Factor Bias and Innovations: A Microeconomic Approach

Abstract

This paper contains a microeconomic analysis of the influence of change in relative prices on the direction of inventive activity. A control-theory model of a firm which produces final output and also performs research and development is developed. It is assumed that the output of R & D is factor-augmenting technical change. An innovation possibility frontier for the firm is defined and conditions are found under which it is convex. The major theorems relate the change in innovation in response to changing factor prices to the elasticity of substitution in producing final output and to the nature of the production functions for innovation. Two special cases are examined in detail. When current innovation possibilities are appropriately independent of past innovations, the rate of factor augmentation is the same for all factors where relative prices are constant at any level. Comparing time paths with different, constant relative prices gives conditions under which an increase in the price of a factor directs innovation into lines which economize on that factor. A summary of earlier results on similar subjects is included.