Economic growth is another instance of manna from heaven, and also a phenomenon that has been with us since the dawn of mankind.
An invention in one industry will generally have consequences for the entire economy. The industry of origin can seldom claim all proceeds. When the optimal ratio of production factors changes, then prices change. E.g. just by mentioning the possibility of other prices, one signals to the other parties that there is room for discussion. The other parties will use that room, and their knowledge and possessions, to claim part of the economic value of any innovation. Other parties have had no effort in bringing about the innovation, but they consider themselves partners in the industry, they know their leverage, and, thus, exploit it. Their advantage not only concerns the consequences of a better product, but also an improvement of their income position.
Model
In a general equilibrium framework we consider an economy with 400 units of labour and 600 units of capital. The economy produces food and clothing, and a social welfare function (SWF) determines the optimal combination. Here, our SWF will be a Cobb-Douglas function that neglects the distribution of income:
(SWF)
Labour a en capital k are allocated to the food (v) and clothing (k) industries via av + ak = 400 and kv + kk = 600. Industrial output is determined by the production functions. Here we take CES-functions, that have a constant elasticity of substitution between capital and labour:
