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Average-cost Pricing, Increasing Returns, and Optimal Output: Comparing Home and Market Production

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  • Yew-Kwang Ng
  • Dingsheng Zhang

Abstract

A model with both market production and home production is used to show that, ignoring administrative costs and indirect effects (such as rent-seeking), even if both the home and the market sectors have the condition of increasing returns and there are no pre-existing taxes, it is still efficient to tax the home sector to finance a subsidy on the market sector to offset the under-production of the latter. This under-production is due to the failure of price-taking consumers to take account of the effects of higher consumption in reducing the average costs and hence prices, through increasing returns or the publicness nature of fixed costs. Within market production, it is efficient to subsidize more the sector with a higher fixed cost, a lower elasticity of substitution between goods (higher value of diversity), and a lower degree of importance in preference which all increases the degree of increasing returns.
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Suggested Citation

  • Yew-Kwang Ng & Dingsheng Zhang, 2007. "Average-cost Pricing, Increasing Returns, and Optimal Output: Comparing Home and Market Production," Journal of Economics, Springer, vol. 90(2), pages 167-192, March.
    • Handle: RePEc:kap:jeczfn:v:90:y:2007:i:2:p:167-192
    DOI: 10.1007/s00712-006-0229-z
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    References listed on IDEAS

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    1. Kenneth J. Arrow, 1995. "Returns to Scale, Information and Economic Growth," Palgrave Macmillan Books, in: Bon Ho Koo & Dwight H. Perkins (ed.), Social Capability and Long-Term Economic Growth, chapter 2, pages 11-18, Palgrave Macmillan.
    2. Bon Ho Koo & Dwight H. Perkins (ed.), 1995. "Social Capability and Long-Term Economic Growth," Palgrave Macmillan Books, Palgrave Macmillan, number 978-1-349-13512-7, October.
    3. Geoffrey Heal (ed.), 1999. "The Economics of Increasing Returns," Books, Edward Elgar Publishing, number 1041.
    4. Heal, G.M., 1997. "The Economics of Increasing Returns," Papers 97-20, Columbia - Graduate School of Business.
    5. Paul Krugman, 1982. "Trade in Differentiated Products and the Political Economy of Trade Liberalization," NBER Chapters, in: Import Competition and Response, pages 197-222, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Andreas Wagener, 2010. "Ng, Y.-K.: Increasing returns and economic efficiency," Journal of Economics, Springer, vol. 100(1), pages 85-89, May.
    2. Zhang, Dingsheng & Cheng, Wenli & Ng, Yew-Kwang, 2013. "Increasing returns, land use controls and housing prices in China," Economic Modelling, Elsevier, vol. 31(C), pages 789-795.
    3. Wenli Cheng & Dingsheng Zhang, 2021. "Optimal Environmental Tax-Subsidy Regime in the Presence of Increasing Returns," Annals of Economics and Finance, Society for AEF, vol. 22(2), pages 525-540, November.
    4. W. Max Corden & Peter Forsyth & Christis G. Tombazos, 2008. "Distinguished Fellow of the Economic Society of Australia, 2007: Yew‐Kwang Ng," The Economic Record, The Economic Society of Australia, vol. 84(265), pages 267-272, June.
    5. Shi, Hui, 2012. "The efficiency of government promotion of inbound tourism: The case of Australia," Economic Modelling, Elsevier, vol. 29(6), pages 2711-2718.
    6. Christopher Colburn & Haiwen Zhou, 2022. "The partition of production between households and markets," International Studies of Economics, John Wiley & Sons, vol. 17(1), pages 21-35, June.
    7. Dingsheng Zhang & Wenli Cheng & Yew-Kwang Ng, 2012. "Increasing Returns, Land Use Controls and Housing Prices," Monash Economics Working Papers 12-14, Monash University, Department of Economics.

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    More about this item

    Keywords

    increasing returns; average-cost pricing; monopolistic competition; home production; optimal output; fixed costs; D43; H21; L11;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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