Two Types of Innovation and Their Economic Impacts: A General Equilibrium Simulation

Abstract

In the traditional two-sector growth model, we show that the real wage rate and the rate of profit converge to positive values when the “constant returns to scale” is assumed. When the “decreasing returns to scale” is assumed, however, the real wage rate converges to zero. Thus, we examine how the trajectories are modified by the creation of a third sector, under the “decreasing returns to scale”. First, we examine the downstream innovation: i.e. the third sector produces a new luxury. This innovation is temporarily effective since it raises the average rate of profit, while the rate converges to the same positive value as in the basic model. Next, we introduce the third sector which produces a new energy: the upstream innovation. This innovation is temporarily effective in raising the real wage rate and the rate of profit so long as it takes place in the early stage. These rates, however, converge to zero. Although the effect on the rate of profit in the downstream innovation is greater than the upstream innovation, it is because the total investment in the latter is greater than the former. Thus, we conclude that the upstream innovation has stronger economic impact.