Increasing Returns and Economic Efficiency

This paper argues that, from the viewpoint of Pareto optimality, the industries with increasing returns are under-expanded relative to those without increasing returns and those with higher degrees of increasing returns are under-expanded 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. This argument is related to the original Pigovian case for encouraging industries with increasing returns (Section l), demonstrated for the general case (Section 3) and illustrated for a specific case (Section 4), after providing an existence proof of average-cost pricing general equilibrium (Section 2).