In neo-classical economics, it is assumed that all resources are efficiency employed in the productive activities maximizing welfare. Under such conditions, if a new constraint is introduced (say to limit environmental externalities of the productive activity) the adjustment to this new constraint has to be costly. If such adjustments can be made at a profit or at no cost, then the initial assumption of efficiency in resource use is violated.

In the real world, our understanding of innovation and how to shape it is rather limited. Furthermore, conjecture by folks like Porter and empirical evidence from studies by Morgenstern and others suggest that not all adjustments to productive activities (will be) or have been costly. Therefore, it is interesting to explore conditions under which we can seek to change a production practice without incurring significant costs.

In order to explore this question we have devised a simulation environment in which firms compete for market dominance by investing in R&D towards radical and incremental innovations and their introduction to the market. We have explored:

(i) the implications of different strategic approaches to management of R&D and product development;
(ii) the implications of information flow constraints on firm level income and societal welfare;
(iii) the impact of signaling and timing of regulations;
(iv) the choice of different instruments to control emissions;
(v) the implications of different rules for division of market spoils;
(vi) the implications of different patterns to the development of environmental consciousness and regulations.

We have only just scratched the surface of the problem using this new approach and plan to expand our research to include issues in human capital development in the near future.