The Economics of Innovation
associate professor of
new modeling methods
to predict performance
and guide policy in
The accelerating pace of innovation — particularly in durable goods industries — has challenged economists to uncover new modeling methods to predict performance and guide policy. Eller associate professor of economics Gautam Gowrisankaran, a McCoy/Rogers Fellow, was recently awarded a three-year, $207,164 grant from the National Science Foundation (NSF) to fund an ongoing project exploring those methods with Marc Rysman of Boston University.
The pair is focused on understanding the dynamics of pricing in the consumer electronics market, specifically DVD players, digital camcorders, and digital cameras. Their work is pioneering new methods for solving dynamic models of consumers’ demand and firms’ supply decisions in these markets.
“Consumers in these markets often delay purchases in anticipation of future price decreases and quality increases,” Gowrisankaran explains. “It makes sense for a firm to begin by pricing a product high, then lowering the price over time.” This strategy allows the firm to capitalize on the consumers who can’t wait — the early adopters — as well as the people who Gowrisankaran says “like, but don’t love” a product, the ones who wait and buy it later.
“The rapidly evolving nature of these industries suggests that modeling dynamics could be very important in estimating consumer preferences,” he explains. “We want to capture this phenomenon and understand how it affects antitrust and regulatory policy, as well as issues in marketing and management.”
The project is also exploring network effects — the way that a product’s value increases as more people adopt it. For example, the network of buyers and sellers who add value to eBay, or the way that third-party apps add value to the iPhone. When a product or service has a strong network, it creates significant hurdles for competitors to overcome.
The new high-definition Flip digital
camcorder with built-in YouTube
compatibility is an example of the
type of rapidly evolving technology
In their earlier work, Gowrisankaran and Rysman built on the static models of demand to develop dynamic models of consumer preferences for new durable goods. “These models are also relevant for other researchers who estimate dynamic demand systems, study durable goods markets, or study oligopoly interactions,” he says. Oleksandr Shcherbakov, a 2008 Eller Ph.D. alum now completing his post-doctoral work at Yale, used the models in a study on the extent to which satellite television can be an effective competitor for cable television.
Gowrisankaran will continue to work with graduate students pursuing complementary work in the area, but is also hoping to expose undergraduate students to the project. “We need to teach them more than just what’s in the textbook,” he says. “As scholars, we can expose them to research projects that are on the frontier.”
Gowrisankaran presented some initial findings to economists with the U.S. Bureau of Labor Statistics in Washington, D.C., on December 17th.
“Innovation is what drives the economy,” he says. “Understanding how the cycle plays out is important. The key linkage in our project is the dynamic consumer, one who will be facing a decision now and in the future.”
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