Investment in knowledge: A generalization of learning by experience

Learning is often perceived as a cost-reducing endogenous by-product of production processes. In many applications this by-product is modeled as a learning curve; that is, a simple function of time or of cumulative production experience. In an ealier paper the authors presented an alternative explanation where managers decide what resources to devote to knowledge acquisition. In this paper they expand those results to a situation using a more flexible production technology and emphasizing discounted cost. The present model explains resource and output behavior for a firm that is producing specialized units to contractual order. However, the results are quite general and have implications for investment in research, engineering, science and technology, software development, and worker training. The authors provide examples where the cost-minimizing producer will choose to invest in knowledge creation early in the production program and then have the rate of investment decline over time. Other interesting results are noted by examining the optimal time paths of the control and state variables in a comparative dynamics analysis.