Innovation Economics :

A new belief / theory which revolves round innovation being the main
cause for the trade cycle.

Propounded by Mr J.A. Schumpeter - around 15 years back.

Knowledge , technology , entrepreneurship and innovation are positioned

at the centre of the model

JOSEPH ALOIS SCHUMPETER

Joseph Alois Schumpeter (8 February 1883 8 January 1950) was

an Austrian American economist and political scientist. He briefly served
as Finance Minister of Austria in 1919

SCHUMPETERS MODEL OF ECONOMIC

GROWTH

ROLE OF INNOVATION
An innovations may consist of:
1.The introduction of a new product
introduction of new method of production

2.The

3.The opening up of a new market

4.The conquest of a new source of raw material
According to Schumpeter ,it is the introduction of new product /
process and the continual improvements in the existing ones that
lead to growth and development.

ROLE OF ENTREPRENEUR
Schumpeter identifies entrepreneurial profit as the prime motivatorthe
premium put upon successful innovation.
Schumpeter says that 'Entrepreneur' is such a factor of production who
introduces new combinations of factors of production
In order to perform his economic functions the entrepreneur is need of two
things:
(i) He must be having technical knowledge so that he could produce new
goods.
(ii) He could easily get the funds. In this respect, credit plays an important
role. Because of credit, an entrepreneur gets a command over
factors
of production.

BREAKING THE CIRCULAR FLOW

Schumpeters model starts with the breaking up of the circular flow with
an innovation in the form of a new product by an entrepreneur for the
purpose of earning profit.

In order to break the circular flow ,the innovating entrepreneurs are

financed by bank-credit expansion.

Investment in innovation is risky, they must pay interest on it. Once the
new innovation becomes successful and profitable, other entrepreneurs
follow it.

Innovations in one field may induce other innovations in related fields.

The emergence of motor car industry may in, in turn ,stimulate a wave of
new investments in the construction of highways ,rubber tyre etc.

CYCLIC PROCESS

Investment is assumed to be financed by creation of bank credit.

It increases money incomes and prices and helps to create a cumulative

expansion throughout the economy.

With the increase in purchasing power of the customers, the demand for
the products of the old industries increases to the supply.

Price rise ,profit increase and old industries expand by borrowing from the
banks. It induces a secondary wave of credit ,inflation which is
superimposed or the primary wave of innovation

After a period the new products start appearing in the market displacing
the old products and enforcing process of liquidation and readjustment.

The demand for old product is decreased. Their price fall. some are even
forced to run into liquidation.

As though innovators start repaying bank loans out of profits, the quantity
of money is decreased and prices tends to fall. profit decline. Uncertainty
&the impulse for innovation is reduced.

Depression entered.

Analysis begun with the assumption that countrys economic performance is in

rigid condition, i.e., there are no population growth and net investment, and high
level of unemployment. Some entrepreneurs committed to reformation and
followed by other entrepreneurs until there is an increase in investment

The impacts are increasing in societys income and consumption. This

phenomena will lead the entrepreneurs to increase the new capital.
(a)induced investment increasing of investment because of increasing in
income , production and profit.
(b)autonomous investment investments which determined by long-term
development, such as new resources found and technology which can create
reformation

TRENDS OF GROWTH IN THE

SCHUMPETERS MODEL

The economic development (booming period) will be followed by

economic recession

Some entrepreneurs who cannot compete with those entrepreneurs whose

have done reformation will subsequently failed in their business and lost
their market and have to close their business.

Creation of new products will lead to uncertainty among the entrepreneurs

in terms investment and capital that are needed for business development

Those entrepreneur who are able to create the new products and market will
lead to economic booming However, the equilibrium point is higher than
the economic recession period.
With the new equilibrium, the level of per capita income is higher.

PREDICTION OF THE DEMISE OF

CAPITALISM

Like Karl Marx Schumpeter also thinks that eventually the capitalism will
come to an end and it will be replaced by Socialism.

In this respect, he gives following arguments:

(i) Along with the evolution of capitalism the entrepreneurs and their
techniques of production will get obsolete. The salaried managers will takeover the charge of industrial units in place of entrepreneurs.

(ii) Along with the growth of capitalism the 'Liberalism' will increase. This
will weaken the institution of 'Monarchy'. The capitalistic class will get
weaker, and it will depend upon civil and military bureaucracy. In this way,
an unrest will develop in the society.

(iii) The capitalism provides the right to speak and write. The people will
express their dissatisfaction against capitalism in tea-houses, parks, hotels
and in journals and newspapers.

In this way, the capitalism will finally convert into socialism. Thus according
to Schumpeter the capitalism will have a 'Self-Demise".

CRITICISM OF THE THEORY

In Schumpeter Model 'the inventor and innovator has been accorded as an

'Ideal Man'. But now a days the inventions and innovations are the routine
activities of industrial concerns.

Schumpeter regards innovation as the main cause of economic development

Too much importance to bank -credit

It is wrong to say that society, will eventually move towards socialism. As if

we analyse Europe and America like capitalist countries they have a higher
degree of industrial development. They have a right to speak and write. But
till now no possibility has emerged whereby the rich capitalist country
could turn towards socialism. While the reverse has occurred and the
socialists countries are converting themselves into 'Market Economies',
after the disintegration of Soviet Union.

DIAGRAMATIC REPRESENTATION OF THE

SCHUMPETERIAN MODEL

BIBLIOGRAPHY
OFFLINE SOURCES OF INFORMATION

INTERNATIONAL ECONOMICS-J.E.CURRY

THE THEORY OF ECONOMIC DEVELOPMENT:AN ENQUIRY

INTO PROFITS,CAPITAL,CREDIT,INTEREST & BUSSINESS
CYCLE-J.A.SCHUMPETER

FUNDAMENTALS OF FINANCIAL MANAGEMENT-EUGENE

BRINGHAM & JOEL F. HOUSTON

ONLINE SOURCES OF INFORMATION

WIKIPEDIA

THE ECONOMIST

ECONOMICSCONCEPT.COM