The concept of innovation needs to be considered in conjunction with related terms, including invention, which is the act of creating something new; technology, which is our body of what we know about producing and consuming; entrepreneurship, which is the risk of organizing production; and institutions, which are the norms that provide framework and structure of society.

Invention... Not

• Invention: An invention is the act of creating something new, something that had not previously existed. The invention might be a product, such as a device that automatically ties your shoe strings. Insert shoe, push button, then remove shoe with tied shoe strings. However, an invention can also apply to ideas, organizations, or production techniques. You might invent a new word, such as psaibenz, which as far as you know means slurping a carbonated soft drink. Or you might be a state legislator who writes a law that bans psaibenz.


• Innovation: In contrast to invention, an innovation is applying this newly created something, making it available for use. You don't have to be an inventor to be an innovator. Inventing a device that ties shoe strings might be an act of sheer genius, but innovation occurs only when it's available for use. Your invention of the word psaibenz does not rise to the innovation status if you are the only one who knows what it means. While innovation inevitably relies on the previous act of invention, invention does not guarantee innovation.

A Word on Technology

Innovation is often thought of as advances in technology, the creation of high technology devices. Many are. But an innovation might also be a new, improved method of sharpening an axe. Or it could be a new, improved method of selling axes. Or it could be a new, improved law regulating axe sharpening. Or it could be a new, improved scientific theory explaining how an axe splits wood.

An innovation can apply to more than just what we know about production and consumption. It can apply to any and all aspects of society, the economy, the political system, and civilization.

Innovation and Entrepreneurship

In many cases entrepreneurs are also innovators. Not only do they organize production, but they do so in the pursuit of an innovation. And innovators often need to take on the risk of organizing production. However, not all innovation involves entrepreneurship. And entrepreneurship does not always require an innovation.

For example, an entrepreneur might organize the production needed for a restaurant that sells hamburgers, french fries, and milk shakes using tried and true production techniques. Nothing new, nothing innovative. Or an innovator might initiate the dissemination of a new term for slurping a carbonated soft drink, psaibenz. Doing so does not really involve the entrepreneurial risk of organizing production.

Institutions

This framework establishes the "rules of the game" under which members of society operate. Institutions can be both formal, such as government laws, or informal, such as cultural practices. By their very nature, institutions create structural rigidity. In many cases they are so intertwined with the fabric of society that only outsiders recognize their existence.

An innovation is essentially a change in an institution. The innovation might be a modest adjustment of an institution, such as adding steel-belted tires to a car. Or it might be the complete replacement of one institution with another, such as the replacement of Paganism with Christianity in the later days of the Roman Empire.

The institution, for instance, might be as simple and straightforward as a good that is regularly consumed by many members of society. The innovation would then be a new good that offers an improved substitute for the old. People once consumed music by listening to vinyl records. Eight-track tapes were an innovation that offered an alternative. Cassette tapes were another innovation. This was followed by the innovation of compact discs. Then MP3 digital music emerged as a more recent innovation. In each case, the innovation changed the way that people consumed music. It changed the institution of music consumption.

Because institutions are many and varied, innovations are also many and varied. Innovations affect more than just the production and consumption of goods and services. An innovation can change the cultural institution of how people are married. Or how politicians finance their campaigns. Or how science explains the formation of stars. Innovations can change how we produce, how we consume, how we live, how we think, how we interact, how we do almost everything that we do.

Institutions by their very nature provide structure and rigidity to society, rigidity that actually inhibits change, change that results from innovations. Therein lies an ongoing conflict between institutions and innovations. Innovations change institutions. But institutions are resistant to change. Institutions that change easily and frequently are ineffective. However, institutions that fail to change, that fail to keep pace with the progress of society, become counterproductive.

Innovative Behavior

Two types of behavioral inclinations can be identified. Most people have both to varying degrees. Some lean more in one direction than the other.

• Managerial: This type of behavior is a preference for maintaining the status quo over changing it. Managerial types resist innovation. A change in institutions does not generate satisfaction for managerial types. On the contrary, satisfaction is best achieved from keeping things structured and orderly.


• Entrepreneurial: This type of behavior has a preference for changing the status quo over maintaining it. Entrepreneurial types embrace innovation. A change in institutions generates satisfaction for the entrepreneurially inclined. Keeping things structured and orderly is not nearly as satisfying.

Consequences

• Prosperity: Innovations are a new and better way of doing things, an improvement in the institutional framework of society. The improvement is most pronounced in living standards and well-being. Innovations generate greater prosperity.


• Economic Instability: Innovations are also credited with triggering business cycles through a process termed creative destruction. Innovations, especially product innovations, trigger investment in capital needed for production, which then stimulates the expansionary phase of a business cycle. However, once the innovations have run their course, saturating the market, investment slows and the economy enters the contractionary phase of a business cycle. Out of the contraction emerges new innovations that launch the expansionary/contractionary process once again.


• Profits: At the microeconomic firm level, innovations generate economic profits. Firms that undertake the risk of innovative behavior might reap the reward of profit. Profit arises as the firm offers a product that is newer, better, and an improvement over existing products offered by the competition. The result is profit.

Innovative Market Structures

On one end of a continuum of market structures is perfect competition, with a large number of small competitors, no market control, perfect information, and the freedom to enter and exit the industry. At the other end is monopoly, with a single firm, complete market control, restrictions on information, and high barriers to entry and exit.

Between the extremes, residing close to perfect competition is monopolistic competition, with a large number of small competitors, with a modest degree of market control, relatively complete information, and the freedom to enter and exit the industry. Residing closer to monopoly is oligopoly, with a small number of large competitors, a great deal of market control, limited information, and barriers to entry and exit.

Innovation is not equally likely for each of the four market structures. Perfect competition is not inclined to engage in innovation because it cannot recoup any of the profits or rewards. The innovation is quickly acquired by other firms in the industry. At the other end of the continuum, monopoly likewise has no innovation inclination because it already has complete control of the market. There is no additional profit to be generated from innovations. Monopolistic competition is also reluctant to undertake innovation because, like perfection competition, other firms in the industry quickly acquire the innovation.

That leaves oligopoly, which is the market structure most likely to pursue innovation. An oligopoly firm is always seeking ways to gain a competitive advantage over other firms in the industry. Innovation is just the thing to accomplish this. Barriers to entry mean an oligopoly firm can enjoy the benefits and profits of innovation.

Innovation Profit

Economic profit is generated for two reasons -- market control and innovation. One source of economic profit is market control, such that a firm has the ability to charge a price that exceeds the opportunity cost of production. The other source is innovation, in which a new product or production technique gives one firm a competitive advantage over other firms.

Identifying the exact source of economic profit is not always that easy. For example, suppose a pharmaceutical company generates economic profit from selling a new drug. Is this economic profit the result of innovation, from the development of the new drug? Or is it the result of market control, from patents, from government limitations on the entry of competitors?

Probably. Perhaps. Maybe, maybe not. One or both. Some of one, some of the other. Hard to say.

Diffusion

Being new and unique, being different from what previously existed, innovations emerge at a particular time and at a particular location. The diffusion process is then the dissemination of the innovation throughout society. Compare the innovation diffusion process to dropping a bit of food coloring into a glass of water. The coloring eventually disperses from the initial drop to the entire glass. The dispersion is not instantaneous.

The innovation diffusion process moves through communication and transportation networks, helped by connections between consumers, businesses, and governments. An innovation. say a new product, emerges at one point, in one city. Business produce and market the product. Consumers purchase and use the product. It spreads from neighborhood to neighborhood. Word spreads to another city. They begin to produce and consume the product. As people talk, as people travel, information about the new product spreads to other cities, to other states, even to other countries.