What Should Economists Measure? The Implications of Mass Production
vs. Mass Customization W. Michael Cox And
Roy J. Ruffin
July 1998
Research Department Working Paper
98-03 Federal Reserve Bank of Dallas
This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (
[email protected])
*What ShouldEconomistsMeasure?The Implicationsof MassProductionvs. MassCustomization"
Bv W. MichaelCox and Rov J. Ruffin.
-Cox:
FederalReserveBankof DallasandSouthemMethodistUniversity. Ruffin: University of HoustonandFederalReserveBank of Dallas. We wish to thankNathanBalke,David Gould,GregHuffman,EvanKoenig,andFinn Kydlandfor their remarksandabsolvethemof all responsibilityfor our conclusionsor errors. The FederalReserveSystemis not responsible for the viewsexpressed here.
What ShouldEconomistsMeasure?The Implications of MassProductionvs. MassCustomization
In the early days of massproduction Henry Ford remarked:"Peoplecan have the Model T in any color-so long as it's black." But in today'smasscustomizationeconomythe consurnercan choose.rmong 1200 different vehicle styles.r Examplesin other sectorsare equally robust. Jeans,shoes,eyeglassesand more come in personalizedpairs. Consumerscan have their own personalcollagen cloned and injected to remove wrinkles. Even a stapleproduct like milk comesin many varieties-with or without hormonesadded. Via the Internet, immigrants can listen to radio from virtually any homeland. Over 170,000different software progftrmsnow exist to hne tune increasinglyevery aspectof cuslomer choice.2 Microeconomictheory has reflectedthis change. Indeed,it has been over two decades sincethe classicpaperby Dixit and Stigltiz (1977) showedthat profit maximization and free entry can lead to optimum product diversity in a monopolistically competitive environment. This work implies that the utility consumersenjoy from masscustomizationis not registeredby GDP. While the measurementproblems of GDP are well known (Krugman, 1998),the dramatic implications of masscustomizationfor what economistsshould measureare not widely appreciated.Simple, well-establishedeconomicsshowsthat even if we could properly account for the measurementof quality (Nordhaus,1994),GDP registersonly technological improvementsthat lower the marginal cosLof producing existing goods. Drawing on the work of Krugman (1979, 1980, l98l), this note seeksto tell the story with a one-paragraphderivation of the basic Dixit-Stiglitz-Krugman model of monopolistic competition. The basictheoremis that as thefxed costsof creatingnew productsfall toward
zero, utility soarsto infinity while GDP remainsconstant. We hope that a shorterand different derivation of this old result will focus attentionon the distinction betweenmassproduction and masscustomizationand offer one explanationfor the Solow Paradox-that "you can seethe computerage everywherebut in the productivity statistics" (Solow, 1987). The Krugman model can be expressedas follows. There aren productswith identical labor cost functions of the form d + Bx, where a and B are the fixed and variable costsand x is the output ofeach product. The utility function is of the form z=nrlox, which is a reductionof the function rl=[X(n)0]r/0for the caseofidentical cost functions and identical market behavior for eachgood. We assume,of course,that 0
