The Efficiency of Encouraging Goods with High Degrees of Increasing Returns

Abstract

From the viewpoint of Pareto optimality, goods with increasing returns are under-produced relative to those without increasing returns; goods with higher degrees of increasing returns are under-produced relative to those with lower degrees. Ignoring administrative and indirect (such as rent-seeking) costs, subsidies on goods produced under conditions of (high degrees of) increasing returns financed by taxes on goods produced under non-increasing and lower increasing returns may increase efficiency. These results apply even though all goods (including those with increasing returns) are assumed to be produced at prices equaling the average costs of production. This is first shown for a general case in Section 5.1 and next for a specific case in Section 5.2. For the general case, two alternative methods are used, the first establishing a Pareto improvement and the second establishing positive net benefits using a cost-benefit analysis.