Endogenous Technological Change I

The R&D-based growth model, with innovation as the source of growth, began with Romer (1990) variety expansion model, for which he was awarded the Nobel Prize for Economic Achievement in 2020. This chapter explains the basic structure of this economic model. The economy consists of consumers, the final goods sector, the intermediate goods sector and the R&D sector. By purchasing the variety developed by R&D firms, entrepreneurs apply for patents and enter the intermediate goods market as monopolists. The monopoly profit is distributed as dividends to households that provide the R&D funds. As the variety increases, labour productivity improves and GDP rises. By introducing stocks in the market, total factor productivity is internalised and economic growth is generated through innovation. Through the scale effect, the increase in R&D workers, accompanying population growth, promotes economic growth. In the lab-equipment model, where R&D firms develop variety through goods rather than labour, the stock price remains constant, hence, the three-dimensional dynamic system becomes one-dimensional and the model analysis becomes simpler.