ELSEVIER Japan and the World Economy 7 (1995) 443-445

Q , ~ n and the RLD

ECONOMY

Product innovation with mass-production: Insufficient or excessive?: Comment

T h o m a s Russell *

Santa Clara University, Santa Clara, CA 95053, USA

It is a pleasure to be invited to discuss Professor Nishimura 's rich paper. In the language of a Broadway theater, this paper is what is known as a "twofer", because it is really two papers for the price of one. These two papers are:

1. An analysis of the degree to which markets provide the correct variety of retail establishments in a circular city.

2. An analysis of the degree to which markets provide the correct variety of manufactured goods in the presence of economies of scale.

In both cases the conclusion is the same. Markets may provide too much variety or too little variety, depending on the circumstances, and in both cases the reason is the same. Market outcomes are determined by the behaviour of the marginal actor, but socially optimal outcomes must be responsive to the wants of the average actor. In the two circumstances considered by Professor Nishimura, marginal and average wants may not coincide.

All of this is worked out in the paper in some detail. In my comments I will not respond to these technical details for two reasons. (1) The mathematical argu- ment in the paper is extremely clear and intuitive so there is no point in repeating it and (2) Because of previous work in this area, it is known that the central thrust of Professor Nishimura 's argument must be correct.

The circle of ideas discussed by Professor Nishimura was, to my knowledge, first discussed by James Meade. For example in Meade (1973), p. 33, he states:

"Because of economies of large-scale production there will be room in the market for only a limited number of products from which consumers may make

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444 T. Russell~Japan and the World Economy 7 (1995) 443-445

their choices. There may, for example, be room in the market for only two car models although there are, say, six models - A, B, C, D, E and F - all of which are equally easy to produce. Some consumers may prefer models C and D to have been put on the market, whereas in fact it is models A and B which have been selected for production. This is clearly analogous to a 'public good'. All con- sumers who are interested in cars at all have to share the same range of choice between available models. The actual car which I buy is a 'private good'; it enters my utility function and not yours. But the range of cars from which we can choose is a 'public good' which we must share in common."

Perhaps because of his Mandarin style, Meade's ideas did not take root in the soil of North American economics. In a number of contributions, Lancaster, for example, re-examined the problem of the trade-off between variety of products and economies of scale (Lancaster 1975, 1979, 1980). Commenting on the last of these papers, Leffler (1980) noted the earlier work of Meade, and went on to note that the two problems discussed by Professor Nishimura, the optimal location problem and the optimal variety problem have the same mathematical structure. In this discussion Leffler quoted from Meade (1974), "the number and variety of products produced may, in fact, turn out to be greater or to be less than optimal," to which Leffler himself added "and, I may add, may turn out to be optimal."

The equivalence between locational inefficiencies and production inefficien- cies, however, has historical as well as mathematical roots. Meade wrote his 1974 paper on production inefficiency as an explicit reworking of an earlier paper by Stern (1972) in which Stern generalized the location problem of Hotelling and reached the same conclusion as Professor Nishimura, that there could be too few or too many stores. (Stern, however, did not have the discount store feature of Professor Nishimura's model.)

Even this, however, is not the beginning of the story. If one wished to ask the question, where does the tension between average and marginal behaviour first appear in economics, an obvious candidate would be Pigou's famous example of the two roads (Pigou, 1919, p. 94). Recall that in this example, there are two roads between cities A and B, one uncongested but slow because it is bumpy, the other potentially fast but therefore congested. Decision making by the marginal driver will lead to a level of congestion on the fast road which equalizes the time of transit on the two roads. This however, cannot be socially optimal, since, if we move one driver from the congested to the uncongested road, that driver's transit time (utility) is unchanged, but all other drivers on the congested road find that their time of transit is reduced so their utility goes up. Thus marginal action is not average maximizing.

Professor Nishimura's results are therefore completely consistent with what we already know. The central question, it seems to me, is what we should therefore do. In particular, I have some concern that in the wrong hands the S te rn-Meade- Lancaster-Nishimura conclusion that in these cases markets may be inefficient is just as dangerous as the kneejerk view on the other side which is that if consumers

T. Russell~Japan and the World Economy 7 (I 995) 443-445 445

want something and it makes profits it must be socially desirable. Much as we all love the old ways, we surely cannot become economic Luddites, arguing against every new large store or mass produced good just because marginal may not maximize average.

For example it is a pleasure to stay at a traditional Japanese inn which has been in the same family for 500 years. However, it is also a very expensive experience. Should the citizens of Japan be denied the right to stay at a Holiday Inn because it may be socially efficient?

To be more precise, let me address two specific questions to Professor Nishimura. First, what in this analysis identifies those cases in which market failure is more likely to be a problem, and which specific factors should govern- ments look into in deciding whether or not to suppress innovation?

Second, if it is decided not to use market forces to determine the variety of products, be it stores or manufactured goods, what should be done instead? Meade, for example, was very explicit that even though there was a potential problem with the variety of automobiles producing under increasing returns to scale, he would not recommend that the choice of which autos to produce be left to a government bureaucrat.

Professor Nishimura talks about setting up a regulatory mechanism with three dimensions, but getting the level of this triple just right is clearly a delicate matter, and the potential for capture would seem to be quite high. The analysis in Professor Nishimura's paper is very thought provoking, but where do we go from here?

References

Lancaster, K.J., 1975, Socially optimal product differentiation, American Economic Review 65, 567-585.

Lancaster, K.J., 1979, Variety, equity and efficiency (Columbia University Press, New York). Lancaster, K.J., 1980, Competition and product variety, Journal of Business 53, $79-S103. Leflier, K., 1980, Comments on the economics of product positioning, Journal of Business 53.

S105-S114. Meade, J.E., 1973, The theory of economic externalities (Sitijoff-Leider, Gen~ve). Meade, J.E., 1974, The optimal balance between economies of scale and variety of products: An

illustrative model, Economica 41,359-367. Pigou, A.C., 1919, Economics of welfare (McMillan, London). Stern, N., 1972, The optimal size of market areas, Journal of Economic Theory 4, 154 173.