7.3.4—Dynamic efficiency

Dynamic efficiency concerns whether firms and markets improve products, processes and productive capacity over time, often through investment, research and development and learning.

A temporary loss of static allocative efficiency may be defended if retained profits finance innovation. The claim must be tested: market power can provide resources for R&D, but it can also weaken the pressure to innovate.

A patent-protected firm may charge above marginal cost today while investing in a lower-cost production method that becomes available later. Whether this is dynamically efficient depends on the size and persistence of the innovation.

Dynamic efficiency is not simply “any investment”, and a monopoly is not automatically dynamically efficient; compare innovation benefits with exclusion and pricing costs.