Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Innovating to effect change: Technological advances

As we describe in the earlier section ‘Testing your faith: Confidence in the economy’, a country’s economy grows in two main ways: factor accumulation (more capital and more labour) and technological progress (finding better ways of producing outputs from inputs).

Rich countries already have large amounts of capital, and adding more people is unlikely to raise income per capita. This situation leaves technological progress as the only real means of increasing living standards over prolonged periods of time.

The natural level of output ( ) is defined by ; so any improvement in technology (represented by the function f) increases the natural level of output. The LRAS curve is vertical at and so shifts to the right. In Figure 9-15, technological progress has increased the natural level of output and shifted long-run aggregate supply from LRAS₁ to LRAS₂, increasing output and reducing the price level.

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Figure 9-15: A positive technology shock.


To invent or not to invent

Technological progress usually follows the generation of new ideas, so economists think that having clear intellectual property rights is important: they ensure that those who create new technologies are sufficiently rewarded. Otherwise, little incentive may exist to invest in the research and development. Firms would prefer to free-ride on the ideas of other firms.

On the other side of the coin, intellectual property rights can’t be excessively generous: for example, giving monopoly rights to a firm to produce something for hundreds of years would shield them from competition and allow them to charge high prices to consumers. A balance is required between giving good incentives to generate new ideas and having competition between firms.