Economic Welfare and the Allocation of Resources for Invention

Posted: 4 Nov 2009

See all articles by Kenneth J. Arrow

Kenneth J. Arrow

Stanford University - Department of Economics

Date Written: 1962


The author raises the classic question of welfare economics in relation to invention: to what extent does perfect competition result in optimal allocation of resources? There are three reasons for the possible failure of perfect competition to lead to optimal resource allocation: marginal-cost pricing, divergence between social and private benefit (or cost), and allocation of resources under uncertainty. The last receives attention in this chapter; specifically, only in the context of uncertainty arises the critical idea of information. Improving the efficiency of the economy with respect to risk may decrease technical efficiency. Devices for mitigating adverse effects of insurance are co-insurance and cost-plus contracts. Uncertainty creates a subtle problem in resource allocation: information becomes a commodity with economic value, and the economic characteristics of information as a commodity, and of invention as a process for the production of information are examined. The classic problem of indivisible commodities applies to information, and the problem of allocation in the presence of indivisibilities appears. The costs of transmitting information create difficulties in allocation. Invention is a process full of risk. Research by corporations is one way to reduce risk. Turning invention into property rights results in underutilization of information. Profitability of invention thus leads to non-optimal resource allocation The failure of a competitive system to achieve an optimal resource allocation is shown to be due to all three reasons (stated above). Incentives to invent can exist for monopolistic and competitive markets. A model is developed, and theoretical reasons are given to explain the biases that result in the misallocations and inefficiencies in the economic system. Some further implications for alternative forms of economic organization are offered. Optimal and efficient allocation of invention could require government or other non-profit finance, and provisions for innovation by individual talents (rather than by firms) could be devised; problems with these approaches are also noted. (TNM)

Keywords: Resource allocation, Economics of information, Innovation process, Inventions, Market competition, Monopolies, Resource management, Information management, Information utilization, Uncertainty

Suggested Citation

Arrow, Kenneth J., Economic Welfare and the Allocation of Resources for Invention (1962). The Rate and Direction of Inventive Activity: Economic and Social Factors: A Conference of the Unive, Vol. , p. 609-626 1962. Available at SSRN:

Kenneth J. Arrow (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

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