The basic theme underlying this chapter is the qualitative change taking place during economic development. Qualitative change is represented by the emergence of new entities, qualitatively different from those that preceded them. Qualitative change gives rise to changes in the composition of the system. In turn, these changes in composition amount to something very similar to structural change. In the model presented in this chapter qualitative change is created by the emergence of new sectors, each of which produces an output that is qualitatively different to, and thus distinguishable from, the outputs of all the other sectors. Each sector produces a differentiated output. Typically such output will be an heterogeneous multicharacteristics product. The output of each sector is produced by a population of firms, whose processes of entry and exit are modelled as part of the dynamics of the sector. The initial stimulus to the creation of the sector comes from an important innovation that creates an adjustment gap, that is, a potential market that when the innovation is created is empty. The model has a strong Schumpeterian flavour in that the first entrepreneur entering a market enjoys a temporary monopoly. This temporary monopoly is eroded by the entry of imitators, which gradually increases the intensity of competition. When the intensity of competition becomes sufficiently high there is no more inducement for anyone to enter the population of firms and there starts being an incentive for incumbent firms to exit the sector. The sector is saturated. The saturation is reinforced as the demand for what was a new product comes to be completely satisfied. In this way the adjustment gap initially created by the innovation is gradually eliminated, thus transforming a niche into a mature market, which becomes one of the routines of the economic system. The saturation of a sector is thus determined by the increasing intensity of competition and by the saturation of demand. Furthermore, exit is also determined by mergers and acquisitions, themselves dependent on returns to adoption. As soon as a sector becomes saturated there is an increasing inducement for incumbent firms to exit and to create a new niche, where once more they will have a temporary monopoly. The same life cycle, constituted by entry, imitation, increasing intensity of competition, saturation of demand, exit will be repeated all over again for each new sector. At the end of it what was a highly profitable niche will become a standard, saturated market. In order for new niches to be created the negative inducements determined by the saturation of a population must be accompanied by some positive inducements for the creation of a new niche. Search activities create innovations and determine the differential fitness of the new technology and the expected differentiation of the niche. Financial availability is another factor required for the creation of firms in a new niche. Different populations of firms thus interact in their evolution. As one pre-existing population saturates, it creates inducements for the creation of new populations. In this sense the creation of new niches becomes the vehicle for variety growth and for the expansion of the economic system.
