Innovation (Economics)

The first successful use of a new product or method or the introduction of a new enterprise on a commercial or extensive scale. New products or services (product innovation) and new methods of production or distribution (process innovation) are usually the offshoot of invention.

By introducing new products and processes, innovation becomes an engine of competition and productivity, which allows consumers to vary their choices and what they consume at a relatively cheaper cost.

Innovation has the potential of endangering smaller firms with diseconomies of scale and less capital to compete, because larger firms, which can increase output at low per-unit cost, can sell their products at much lower prices that cannot be matched by less efficient firms.

Firms that are adequately capitalized and with excess capacity are forced to become more efficient as a result of innovation, by investing in research and development (R&D) to reduce cost and produce competing new products. Executives, scientists, and skilled, salaried employees (collectively known as intrapreneurs, for providing a spirit of entrepreneurship) are actively undertaking R&D for their firms to be competitive and profitable.

The cost of R&D may be reduced by diffusion. Diffusion is the dissemination of innovation through imitation or emulation. Since innovation, unlike invention, is not patentable, savvy firms may copy or emulate the successful innovation of their competitors to minimize short-term losses and stay competitive over a longer time horizon.

Although earlier economists like Robert Solow were less successful in modeling technological progress (considered a residual) in their explanation of economic growth, innovation or technological progress accounts for a considerable amount of economic growth in contemporary growth theories. Empirical results indicate that technology or innovation makes labor much more efficient. For more information, see McConnell and Brue (2008).