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Variety and Growth

Summary:
A closed economy produces only apples, using fixed amounts of labour and land. Suppose there is an exogenous increase in the number of varieties of apples produced. With a constant returns to scale technology, GDP stays the same. But if people have a taste for variety, or a variety of different tastes, people are better off. It's not that the new apples are better than the old apples; but some like them better and some like them worse, and some like some of each. The new apples sell at the same price as the old apples. With increasing returns to scale technology (there is an annual fixed cost of producing each variety of apple), GDP will fall when the number of varieties increases. People eat fewer apples, but eat a bigger variety of apples. People might be better off or worse off, it depends. But the decline in GDP is a downward-biased measure of welfare. What might have caused the increased number of varieties produced? It might have been that new varieties were discovered. Or it might have been that as people got richer, they decided they didn't want more apples but wanted a bigger variety of apples. The second explanation only works if there are Increasing returns due to fixed costs for each variety. Otherwise a market economy would always produce every single known variety, as long as one person wanted to eat one apple of that variety.

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A closed economy produces only apples, using fixed amounts of labour and land. Suppose there is an exogenous increase in the number of varieties of apples produced. With a constant returns to scale technology, GDP stays the same. But if people have a taste for variety, or a variety of different tastes, people are better off. It's not that the new apples are better than the old apples; but some like them better and some like them worse, and some like some of each. The new apples sell at the same price as the old apples.

With increasing returns to scale technology (there is an annual fixed cost of producing each variety of apple), GDP will fall when the number of varieties increases. People eat fewer apples, but eat a bigger variety of apples. People might be better off or worse off, it depends. But the decline in GDP is a downward-biased measure of welfare.

What might have caused the increased number of varieties produced? It might have been that new varieties were discovered. Or it might have been that as people got richer, they decided they didn't want more apples but wanted a bigger variety of apples. The second explanation only works if there are Increasing returns due to fixed costs for each variety. Otherwise a market economy would always produce every single known variety, as long as one person wanted to eat one apple of that variety.

It is perfectly possible to imagine an economy with steadily improving technology of producing apples, where people are steadily getting richer, but apples produced per person (or per acre) stays constant. They are spending all of their increasing income on consuming an increasing variety of apples. But it doesn't show up in the GDP data, or in rising wages or land rents. The production function for each variety is shifting up over time, but people are choosing to move back along that production function keeping the Average Products of land and labour constant.

If the country were Holland, the land would be capital, because new land can be produced.

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