In my ten year software developer career I've only worked for two companies, and both job experienced pre-dated the 21st century and my graduation from college. At both jobs, I only had one monitor, albeit a rather large one for the time (21” at both companies, if I remember correctly). After graduating, I decided to strike out on my own as a freelance writer, consultant, and trainer, and haven't looked back since. Not knowing any better, I used a solitary monitor until April 2006, when I finally updated to a dual monitor setup. I bought a second video card, picked up the same brand/model of monitor, and graduated into the 21st century. (What prompted me to upgrade to two monitors was, primarily, stories of enhanced productivity from my wife, who was, at the time, working for a company that supplied dual monitors to all its devs. Bill Gates is also a big fan of multiple monitors.)
Two monitors are superior to one for many development- and writing-related tasks. Having Visual Studio in one window and the browser in another and being able to see both simultaneously nets huge performance gains. Likewise, when writing, having Microsoft Word up on one screen and code or a browser is a great time-saver. Today I have a hard time functioning when at a client's site and am reduced to using a single monitor setup. But just how much better are two monitors than one?
Anyone who tells you that they are twice as productive with two monitors than with one is probably over exaggerating. For development- and writing-related activities I find that two monitors allows me to accomplish somewhere on the order of 25%-50% more work in a given unit time. That's a wet finger in the air estimate, but there have been more formal studies. Microsoft Research reports that multiple monitors “can increase your productivity by 9 to 50 percent.” A small study performed by Darrell Norton shows productivity as lines of code per day increased by 10% and defect levels decreased by 26% (hat tip Jeff Atwood). What doesn't get measured in these studies is the increased quality of worklife. Even if the actual productivity gain is nominal, having a second monitor feels better. It lets you see more screen real estate at a given point in time. It lets you compare two documents side by side rather than incessantly Alt-Tabbing.
A couple of months ago I upgraded to a new computer. The only components I salvaged from my old computer was a 350 GB S/ATA hard drive and my two monitors; everything else was bought new. While investigating parts and formulating my shopping list I debated whether to upgrade to three monitors. Jeff Atwood is a big fan of three monitors:
As good as two monitors is, three monitors is even better. With three monitors, there's a "center" to focus on. And 50% more display area. While there's certainly a point of diminishing returns for additional monitors, I think three is the sweet spot. Even Edward Tufte, in the class I recently attended, explicitly mentioned multiple monitors. I don't care how large a single display can be; you can never have enough desktop space.
I didn't think a third monitor would make me any less efficient, but I questioned as to whether the improvements in efficiency (or quality of worklife) were as grandiose as Jeff made them out to be. In the end I decided to give it a whirl. I bought two GeForce 8600 GT video cards for the new system. These have dual DVI outputs meaning that I could upgrade to a fourth monitor if I were so inclined. I kept the two monitors from my previous setup - 17 inch monitors from Sharp - and bought a new Samsung SyncMaster 2053 BW monitor, which is a wide screen that has about the same visible height at the Sharps, but is about 33% wider. The two Sharps run at 1280x1024, the Samsung at 1680x1050.

I've been using the three monitor setup for a couple of months now and regret to say that I have not seen the same productivity benefits or improvement of worklife that Jeff espouses or that I enjoyed when going from one monitor to two. For certain tasks I am more productive with three monitors than two, a prime example being if I need to review a client's email while bug bashing. I can have the email open that explains the error in one window, Visual Studio in another, and the web application running in the third. However, for most other activities the third monitor does not add too much value. Consequently, it's not uncommon for one of the three to sit unused for long stretches of time.
Three monitors also have some detriments that weren't present with two. Because of the width of the three monitors, I frequenty tilt my neck to see the side monitors; with two monitors I could see both with when looking straight ahead by just turning my eyes, but not with three. The net result is that if I spend an inordinate amount of time focusing on one of the side monitors my neck becomes a bit stiff. To combat this I try to make myself swivel my chair when I start looking at a side monitor, but it's second nature for me to turn my head and I don't realize that I'm not swiveling until my neck starts to bother me.
In the end, three monitors are better than two, just like I imagine four would be better than three, but the returns on multiple monitors quickly diminish as the number of monitors grow (at least for my line of work and from my personal work habits). Knowing what I know now, if I had to choose between a third monitor and some other upgrade (perhaps a super high-end hard drive or a high-end office chair), I'd stick with two monitors and take my luck with what's behind Door Number 1.