Cost share-induced technological change: An analytical classical-evolutionary model

Abstract

AbstractThis paper builds on prior work by the author on cost share-induced technological change. The theoretical model views selection of candidate innovations as a capital budgeting exercise. In this paper it treats the case in which firms target an incremental rate of profit, which introduces a nonzero threshold into a “selection frontier”. This presents analytical challenges, which are resolved in this paper by assuming that the probability distribution of potential increases in productivity among the set of fit innovations is normal. That permits an explicit derivation of a micro-level model of cost share-induced technological change that can be taken as a candidate functional form for an aggregate model. The model is calibrated against historical data for India, China, and the United States, three large continental economies at different levels of per capita GDP. The model is able to fit the data with reasonable fidelity, and the fitted model parameters can be given a reasonable interpretation. The paper further shows that combining cost share-induced technological change with price-setting behavior produces theoretically interesting results.