Shifting trends in semiconductor prices and the pace of technological progress: is there a link? How close?

Business Economics, July, 2008 by Ana Aizcorbe, Stephen D. Oliner, Daniel E. Sichel

This paper examines three questions motivated by previous research on semiconductors and productivity growth: Why-did semiconductor prices fall so rapidly in the second half of the 1990s? Why has the rate of price decline slowed since 2001? And to what extent are these price swings associated with changes in the rate of advance in semiconductor technology? We show that the price swings are statistically significant and that they reflect changes in both price-cost markups and cost trends. Further analysis indicates that the shift to faster cost declines in the mid-1990s likely corresponded to a speed-up in the pace of advance in semiconductor technology. However, the slower cost declines since 2001 appear not to have been mirrored by a deceleration in technology. Consequently, researchers should be cautious about associating price or cost movements for semiconductors with changes in the pace of underlying technology even over moderately long periods.

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The U.S. economy expanded at a rapid pace in the second half of the 1990s, spurred by a resurgence in labor productivity growth. Considerable research has highlighted a central role for information technology (IT) in that resurgence, reflecting the enormous improvements in price-performance ratios for IT capital goods and, more fundamentally, for the semiconductors that power this capital. (1) In recent years, however, semiconductor prices have fallen less rapidly than in the second half of the 1990s, tempering the price declines for IT capital goods and likely contributing to the more restrained spending on these goods. Given the key role of semiconductors in these developments, three questions demand attention: Why did semiconductor prices fall so rapidly in the second half of the 1990s? Why has the rate of price decline slowed more recently? To what extent are these price swings associated with changes in the rate of advance in semiconductor technology?

Several studies have examined the faster rate of price decline in the second half of the 1990s. Jorgenson (2001) linked the steeper price declines to a shift from three-year to two-year technology cycles in the semiconductor industry. Flamm (2004) and Congressional Budget Office (2002) accepted the view that technology cycles had become shorter, but they asserted that technology alone could not fully explain the more rapid price declines in the late 1990s. Similarly, McKinsey Global Institute (2001) and Aizcorbe (2005, 2006) argued that the speed-up in the rate of price decline reflected, at least in part, heightened competition between Intel and its chief rival, AMD.

We build on this research in three ways. First, we examine not only the shift to faster declines in constant-quality semiconductor prices in the mid-1990s but also the reversion to slower declines since 2001. Little research has focused on the latter period.

Second, we formally test for breaks in the rate of price decline using a state-of-the-art framework that allows us to search for multiple unknown breakpoints. Such statistical evidence is important because it determines whether observed swings in price trends represent more than just random variation and, hence, are worthy of further study. As far as we know, our paper is the first to apply any econometric analysis to this question. We focus on prices for a broad aggregate of semiconductors and for two key types of chips: microprocessor units (MPUs) and dynamic random access memory chips (DRAMs). Using these tests, we find compelling statistical evidence of breaks in MPU price trends in 1994 and 2001 and reasonably strong evidence of similar breaks for DRAM prices. For the series on overall semiconductor prices, the results are weaker, but nonetheless point to a break in 1995.

Third, to examine the source of these breaks, we decompose changes in constant-quality DRAM and MPU prices into changes in price per transistor and a residual that captures quality change beyond the number of transistors per chip. We then decompose price per transistor into a price-cost markup and a measure of cost per transistor. We implement this decomposition for MPU chips using data on Intel's revenues, costs, and chip output. We implement the same decomposition for DRAM chips using data for Micron Technology, the largest DRAM producer in the United States.

For both DRAM and MPU chips, our framework shows that changes in price-cost markups contributed notably to the observed shifts in the rate of price decline. The role for markups is especially pronounced for DRAM chips, which are subject to wide swings in worldwide supply-demand conditions. The decomposition also shows that cost trends have varied over time. For DRAM chips, the downtrend in cost per transistor sped up in the mid-1990s and then slowed around 2001. For MPUs, the story concerning cost reductions is more nuanced than for DRAM chips, as it reflects the combined influence of cost per transistor and improvements in chip quality beyond the number of transistors (the residual term in the decomposition). Still, the basic message is similar to that for DRAMs: MPU cost trends, as measured in our decomposition, were unusually favorable from the mid-1990s through 2001, and less so thereafter.