Daniel l. Rubinfeld

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238 Part 2 Producers, Consumers, and Competitive Markets Chapter 7 The Cost of Production 239 Cost General ~-.lotors. Cost (dollars per unit of output) Vol\'o. Honda
240 Part 2 Producers, Consumers, and Competitive Markets 7 The Cost of Production 241 When Ec = I, SCI = 0 and there are no economies or diseconomies of scale. When Ec is greater than one, SCI is negati\'e and there are diseconomies of scale. Finally, .. vhen is less than I, SCI is positiYe and there are economies of scale. .-\.\'erage Cost (dollars per 1000 65 kwh) 6.0 I n 1955, consumers bought 369 billion kilowatt-hours (kwh) of electricity; in 1970 they bought 1083 billion. Because there vvere fewer electric utilities in 1970, the output per firm had increased substantially. Was this increase due to economies of scale or other factors If it was the result of economies of scale, it would be econornically inefficient for regulators to "break up" electric utility monopolies. - An interesting study of scale economies was based on the years 1955 and 1970 for investor-owned utilities with more than $1 million in re\'enues.I 7 The cost of electric power was estimated by using a cost function that is somewhat more sophisticated than the quadratic and cubic functions discussed earlieL 18 Table 7.4 shows the resulting estimates of the scale economies index. The results are based on a classification of all utilities into five size categories, with the median output (measured in kilowatt-hours) in each category listed. DIe positive values of SCI tells us that all sizes of firms had some economies of scale in 1955. However, the magnitude of the economies of scale diminishes as firm size increases. The average cost curve associated with the 1955 study is drawn in Figure 7.17 and labeled 1955. The point of minimum average cost occurs at point A at an output of approximately 20 billion kilovvatts. Because there were no firms of this size in 1955, no firm had exhausted the opportunity for rehuns to scale in production. Note, however, that the average cost curve is relatively Hat from an output of 9 billion kilowatts and higher> a range in which 7 of 124 firms produced. When the same cost functions were estimated with 1970 data, the cost curve labeled 1970 in Figure 7.17 was the result. The graph shows clearly that the average costs of production fell from 1955 to 1970. (The data are in real 1970 dollars.) But the Hat part of the CLU'\'e now begins at about 15 billion kwh, By 1970,24 of 80 firms were producing in this range. Thus many more firms were operating in the Hat portion of the average cost curve in which economies of scale are not an important phenomenon. More important, most of the firms were producing in a portion of the 1970 cost curve that was Hatter than their point of operation on the 1955 curve. (Five firms were at points of diseconomies Output (million kwh) 43 338 1109 2226 5819 Value of SCI, 1955 .41 .26 .16 .10 .04 17 This example is based on Laurits Christensen and William H Greene, "Economies of Scale in U.s. Electric Power Generation," JOllnla/ of Po/iliCil/ ECO/IOIllI! 8-1 (1976): 655-76. IS The trans log cost function used in this study pro\'ides a more general functional relationship than any of those we ha\'e discussed :;,5 1955 5.0 1970 6 12 18 30 36 Output (billion kwh) The average cost of elech'ic power in 1955 achieved a mirlimum at approximately 20 billion kilowatt-hours. By 1970 the average cost of production had fallen sharply and achieved a minimum at an output of more than 33 billion kilowatt-hours. of scale: Consolidated Edison [SCI - 0.003L Detroit Edison [SCI = 0.004L Duke Power [SCI = - 0.012L Commonwealth Edison [SCI = - 0.014L and Southern [SCI = - 0.028].) Thus unexploited scale economies 'were much smaller in 1970 than in 1955, This cost function analysis makes it clear that the decline in the cost of producing electric power CaImot be explained by the ability of larger firms to take ad\'antage of economies of scale. Rather, improvements in technology unrelated to the scale of the firms' operation and the decline in the real cost of energy inputs, such as coal and oie are important reasons for the lower costs. The tendency toward lower ayerage cost reflecting a mo\'ement to the right along an average cost cun'e is minimal compared with the effect of technological improvement. #§ii Understanding rehlrns to scale in the savings and loan industry is important for regulators ..,\,ho must decide how savings and loans should be resh'uctured in light of the failure of numerous institutions. In this regard, the empirical estimation of a long-run cost function can be useful 19 Data were collected for 86 sa\'ings and loan associations for 1975 and 1976 in a region that includes Idaho, Montana, Oregon, Utah, Washington, and Wyoming. Output is difficult to measure in this case because a saYings and '0------ l.This example builds on J. Holton Wilson, "A I\ote on Scale Economies in the Sa\'ings and Loan Industry," Busillcss Ecollolllics (January 1981): -15--!9
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Daniel l. Rubinfeld

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