The law of diminishing returns, which is important in traditional economics, is being challenged by the phenomena of harvest crowding and network externality in the information technology era, which has led to changes in the structure of modern economies, suggesting the need for new economic models.
Traditional economics assumes that as inputs continue to increase, at some point the rate of growth of output is likely to decline. This view was especially common in traditional industries such as agriculture and manufacturing. This is called the law of diminishing returns, and it was accepted as valid in industrial societies where commodities like grain and iron were central to the economy. For example, if a farm adds more fertilizer or more workers, it may initially increase production, but eventually yields will decline due to natural constraints such as the limitations of the soil.
In a situation like this, of course, as inputs increase, output may initially increase significantly. However, as time goes on, the quality of labor is likely to decline, and the efficiency of labor organization and management is likely to be limited. In addition, there are limits to the efficient utilization of resources, and eventually, the harvest experience will hit a wall. This law has served as a warning to many companies and economists trying to maximize the efficiency of their resources. It teaches us that it’s important to find the optimal level of inputs, not to increase factors of production indefinitely.
When the law of diminishing returns comes into play, companies producing a product will set the scale of production at the right level to maximize profits. The company will no longer increase production indiscriminately, but will try to find and maintain the optimal scale of production. As a result, the market for this product will have multiple firms producing the same product, competing with each other, and the firm that can offer a better product at a lower price will be able to compete in this market. This competition also favors the consumer, giving them the opportunity to buy a better quality product at a lower price.
However, in the information technology age, things have changed dramatically. The law of diminishing returns, where more inputs lead to more outputs, began to emerge in many industries. The information technology era has seen the exact opposite of the law of diminishing returns. It is now common for more inputs to produce more output. This phenomenon can be explained by the sharp decline in the average cost of an output as the scale of production increases. By average cost, we mean the cost of producing one unit of a product. In particular, the information industry, software industry, cultural industry, and service industry, which represent the information technology era, are industries that are characterized by high initial development costs but little additional cost as production increases.
The phenomenon of harvest congestion can be found not only on the supply side, but also on the demand side. Demand-side harvesting is often caused by network externality. Network externality refers to the fact that the more people who use a product, the more valuable it becomes, giving unintended benefits to the company that produces it without paying for them. This is one of the reasons why first movers in a market have a stronger competitive advantage, and these benefits, combined with economies of scale, strengthen their dominance in the market.
Thus, in the presence of network externality, a firm that is already a first mover in a market can continue to increase its production of a product and its profits will not decline according to the law of diminishing returns. Rather, over time, their competitive advantage becomes even stronger and they are able to consolidate their monopoly position in the market. This creates a situation where it’s difficult for new companies to enter the market and gain an advantage over the competition. In a market where the law of diminishing returns is at work, firms will expand production as much as the market size allows, trying to drive competitors out of the market altogether. In addition, network externality gives first-mover firms a significant advantage. New firms will find it very difficult to survive in the market, even if they are competitive in terms of product quality or price.
As a result, competition based on quality or price loses its power in these markets. This means that the economic structure of the information technology era is fundamentally different from the economic structure of the industrial society, and the application of traditional economic theories is limited. The information technology era requires a new economic model, and economic diversification and innovation become more important. This makes it difficult to predict and explain the economy in the way we did in the industrial age. Formulating policies and strategies for the new economic environment has become an essential task for both companies and countries.
