Agricultural Economics Department


Date of this Version



Published in Journal of Agricultural and Resource Economics 19:1 (1994), pp. 161-172. Copyright 1994 Western Agricultural Economics Association. Used by permission.
This is Journal Paper No. J-14900 of the Iowa Agriculture and Home Economics Experiment Station, Ames, Iowa; Project No. 2998.


Economics theorists for years have considered the possibility that the direction of technical change is altered by changes in relative prices. Prices also have been identified as one of the determinants of technical change through innovation, This article extends the theory of the firm to cover situations in which the firms technology set is conditional on expected prices. The basic idea is to distinguish between "market prices," or the prices that guide the firm's choices subject to the technology that is in place, and "normal prices," the prices conditioning the choice of technology. A “generalized" price effect is obtained that includes the traditional price effect as well as the technical change effect of price changes, and an example is presented. The theory of induced innovation argues that technological change responds to price movements so as to save on factors of production that have become relatively more expensive. Early applications of the theory by Hayami and Ruttan, and by Binswanger to the study of agriculture have been useful in explaining long-run historical trends. Output prices also have been identified as a determinant of technical change through innovation, although they have not been as prominent a determinant as input prices. Innovation generally is considered an activity to which a firm allocates resources according to its profitability. Profitability can be affected by supply-side factors, such as the existence of new knowledge or the cost of research, and by demand-side factors, such as price changes or changes in appropriability. The clear implication of this conceptual approach is that increases in expected product prices (or demand) increase innovation benefits. Both Schmookler and Lucas provided empirical support for this hypothesis. Binswanger developed an explicit firm behavior model showing that the benefits of innovation increase with expected prices if the optimal quantity is expected to increase because of innovation. In order to capture the effect of prices on technical change, Fulginiti and Perrin propose a production function for which the coefficients are variable and determined at any one place and time by previous choices and the current technological, natural, and institutional environment. They refer to these as technology-changing variables and focus on the role of prices as a technology-changing variable. The work by Fulginiti and Perrin provides empirical support to the Schmookler-Lucas hypothesis, that is, the existence of a positive price-technical change relationship. This study extends the theory of the firm to cover situations in which the firm's technology set is conditional on expected prices. In particular, it focuses on the implications of price-conditional technology on the producer's behavior, i.e., netput functions properties.