IRS

Isn't she a beauty?
Airbus A380. Click to embiggen in a new tab.

I love IRS. Not the “Internal Revenue Service” but “increasing returns to scale”.

Understanding the economic concept of “returns to scale” is useful for understanding the tremendous increase in the production of wealth in our modern world.

A bit of vocabulary first. The stuff that goes into production are called “factors of production.” The vocabulary is the same as in basic arithmetic where the product is derived from factors — for instance, the factors 2 and 3 when multiplied yield the product 6.

When you increase the factors, the product increases. That is, the “scale” or the size of the operation increases and therefore the product increases. If the increase in production is proportionate to the increase in the factors, then we have “constant returns to scale.” Continue reading “IRS”

India’s Biggest Blessing

This one is in the context of an entry on HP’s Thin Client at Rajesh Jain’s weblog. In response to a bunch of comments on that entry, Rajesh wrote to me:

I think we will need to create the large domestic markets for the affordable computing solutions.

I totally agree. And I am thankful for one positive factor in India’s favor.

The most significant positive factor in India’s favor is its size. It is what we economists call a “large economy”. Large economies have the luxury of changing parameters which define the market itself. In comparison to that, “small” economies have to take those parameters as given (or ‘exogenous’) or external to them or outside their control. In a way, you can consider a large economy to be have some sort of ‘monopoly power’. Monopolies have the power to change one parameter (price) at will which firms in competitive (or oligopolistic) markets don’t have — the latter are ‘price takers’ in that they cannot dictate prices and take whatever price they can get.

So India is large enough to be able to change ‘world prices’. Suppose you were to create a widget which is suited to Indian conditions. Assume that the cost of production of these widgets exhibit economies of scale — that is, fixed costs are extremely high and marginal costs are very low, and hence average costs continue to decline as the volume produced increases. In such a case, given India’s enormous population, the number of widgets required would be high, and thus the average cost will be appropriately low, and therefore the market clearing price for widgets will be low and quantities will be high.

Now replace ‘widgets’ in the above with whatever — “COMPUTING SOLUTION” for instance. Get the hardware that is appropriate for the Indian market developed and get the software developed for the same. Concentrate on the needs of India alone to begin with. Note that hardware and software meet the criteria of high fixed cost and low marginal cost. Marry the hardware and software to create the computing solution, price it just above average cost, and voila! YOU HAVE LIFT-OFF!!

Do we need to create the large domestic market? If by creating you mean bringing the solution to the market, then yes. However, all the ingredients exist. We just have to judiciously put them in them together using the right recipe. I suspect that we are more than up to that job.

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