Productivity Growth from Economies of Scale

Productivity grows because of economies of scale and because of-technological change. Economies of scale and mass production have been important elements of productivity growth over the last century. Most production processes are many times larger than they were during the nineteenth century. A large ship in the mid-nineteenth century could carry 2000 tons of goods, while the largest supertankers today carryover I million tons of oil.

What would be the effect of a general increase in the scale of economic activity? If increasing returns prevailed, the larger scale of inputs and production would lead to greater productivity. Suppose that, with no change in technology, the typical firm’s inputs increased by 10 percent and that because of economies of.scale output increased by 11 percent;

Economies of scale would be responsible for a growth in total factor productivity of 1 percent, while increasing returns to scale are potentially large in man}’ sectors, at some point decreasing returns to scale may take hold. As firms become larger and larger, the problems of management and coordination become increasingly difficult, In relentless pursuit of greater profits, a firm may find itself expanding into more geographic markets or product

Productivity Growth from Economies of Scale

Productivity Growth from Economies of Scale

Assume that each JX!non derives a value oC $1 Cor each additional penon who is connected to a telephone or e-mail network. ICEd decides to join. he “,;11 get 54 of ,.•due Crom being connected to Adam. Beth, Carlos. and Dorothy. But there is an “adoption externality” because each of the four People already in gets $1 of additional value when Ed joins. Cor a total oC 54 of external additional value.

These network effects make it difficult for networks to get started. (To see this. note the low value of joining Cor the first and second person.) But the equilibrium “tips” toward full adoption when many people are in the network. (What is the value to the tenth penon who joins the network?)

lines than it can effectively manage. A firm can have only one chief executive officer. one chief financial officer. one board of directors. With less time to study each market and spend on each decision, top managers may become insulated from day-to-day production and begin to make mistakes. Like’ empires that have been stretched too thin such firms find themselves exposed to invasion by smaller and more agile rivals. Those who study management report that the world’s largest automobile manufacturer.

General Motors, became increasingly isolated from the outside world and from competitive pressures. As a result. it was slow to respond to changes in the automobile market when oil prices’ rose in the 1970s. and it lost much market share to smaller and nimbler firms. Hence, while technology might ideally allow constant or increasing returns to scale. the need for management and supervision may eventually lead to decreasing returns to scale in giant firms.

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