Exercises EPA1222/MOT1421 – Four

Technological Change
1. Essay Questions
Write a short essay on the following questions.

1a. On page 429 (HST, Chapter 15) it is argued that “Innovation is thus just a case in
which perfect competition does not yield the best outcome.” Explain why this is so.

1b. Give your comments on the following proposition:

“Economic selection entails the survival of the “fittest” firm, which means that the
most efficient firms will compete less efficient firms out of the market.” Do you
agree?

2 Growth Accounting

Given are the following data:

Income Hours Worked Capital Stock

(X) (L) (K)
1970 1,000,000 5,000.00 2,000,000
2002 2,070,238 6,054.90 3.652,615

2a. What is the level of labour productivity (per hour worked) in 1970? And in 2002?
What is the (annual compound) rate of growth of labour productivity (in percentages)
during 1970-2002?

2b. Assume that the generation of income X can be described by a Constant-returns-to-

scale production function (as explained in the sheets to Chapter 15). Assume that
β = 0.4. Calculate the rate of total factor productivity (TFP) growth (in percentages)
during 1970-2002 using the formula:
* * *
x  a  k

* *
where x  the growth rate of labour productivity, k  the growth rate of capital
*
intensity (K/L), and a  the growth rate of TFP.

2c. How do you interpret TFP growth? What does it stand for? What does it reflect?

2d. According to some authors, TFP growth is basically a measure of “our ignorance”
about the sources of productivity growth. Do you agree? (motivate your answer).

3 Evolutionary Market Model

Consider the following evolutionary market model (given in HST, Chapter 16):

(1)  it  Pt  C ti
C
(2)  tAV   ( it * S ti )
i A

(3) G   ( it   tAV )
t
i

(4) S ti1  S ti (1  Gti )

(5) C ti1  C ti   (Cti  CtMIN )

C
(6) C tAV   (C ti * S ti )
i A

 = profits per unit of output of firm i. P = the market price. C ti = the cost per unit of
i
t

output of firm i.  tAV = average profits per unit of output; S ti = the market share of firm i.
Gti = the growth rate of the market share of firm i. C tMIN = the minimum cost (realised by
the most efficient firm). C tAV = average cost per unit of output of firms A, B, and C.  = the
selection parameter;  = the imitation parameter. The superscript i refers to firms A, B or C.
The subscript t indicates time period 1, 2, …..
The following are the model’s initial conditions: P = 15; C tA = 9; C tB = 10; C tC =
11; S tA = (1/3); S tB = (1/3); and S tC = (1/3). That is: initially, the (given) market price is the
same for all three firms; firms have equal market shares; and firm A is the most efficient firm,
having the lowest unit cost.

3a. Program this evolutionary market model in EXCEL. Hint: Use the following format:

Time  tA  tB C
t S tA S tB S tC  tAV GtA GtB GtC C tA C tB C tC C tAV C tMIN

Apply the evolutionary market model assuming that  = 0.3 and  = 0.8. What
happens over time to the market shares of A, B and C? What happens to average unit
cost?
3b. Apply the model assuming that  = 0.5 and  = 0.5. Further assume that Firm C
(because of a superior marketing strategy) can sell its product at P = 18. What happens
over time to the market shares of A, B and C? What happens to average unit cost?
What general lesson can we draw from this simulation experiment?
3c. Apply the model assuming that  = 0.5 and  = 0.5 and P = 15 for all firms.
Describe and explains what happens to market shares and average unit cost 
declines (to 0.3 and further down to 0.1) and  rises (to 0.7 and 0.9). What lesson can
be drawn from this experiment?