Sunday, July 31, 2011

At the edge you can see the future

The future could depend on whether marginal costs rise or fall.

Economists often talk about marginal costs. That is the cost of producing one more additional item for sale, as opposed to the average cost of all the items together. A classic example is a seat on the Delta shuttle flight between LaGuardia and National airport Washington leaving tomorrow. The cost of operating the flight so you can fly the first passenger runs into tens of thousands of dollars. But the extra cost of flying the fiftieth passenger is tiny, a few dollars extra to cover fuel expended carrying the extra weight, and any extra ticketing costs. The average cost to fly the fiftieth passenger is hundreds of dollars, but the marginal cost could be ten or twenty dollars. (This is why airline ticketing systems are so complicated).
What does this mean for the economy as a whole?

A lot depends on whether the growing areas of your economy have rising or falling marginal costs. Most classic manufacturing or energy production has rising marginal costs, at least in the short run. If you want to produce more at the margin, you have to run your factory harder, pay more overtime, get closer to capacity limits. If you want to expand production further, you may have to invest hundreds of millions in a new plant. And if there are economies of scale, there may only be room for two or three large plants in the world, or there will be oversupply and producers will not recover their costs. Over time, costs may fall because of new technology or techniques, but you still need more resources to produce more.
For much of our new information economy, on the other hand, marginal costs are zero, or close to it. You can sell a hundred million copies of Mac OS Lion for much the same cost as one million, or a hundred. You can write an app and overnight scale up to worldwide availability in the millions.
Clearly you have a very different economy if the new needs that evolve have rising or falling marginal costs. In the later case you can scale up to almost universal, ubiquitous satisfaction of the wants very quickly for little additional money. It is the big rock candy mountain.

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