Discussion of Professor Schneider’s Paper

Professor Baumol said he found the paper fascinating, partly because he himself, together with Professor Fischer, was working on an analysis of the choice of industry structure. He had two comments, first a technical and then a substantive one. On the first point he said that in order to decide whether the firms in a given industry should be amalgamated or broken up to minimise production costs, the theory of natural monopoly was relevant. Recent developments in that theory had shown that scale economies were neither a necessary nor a sufficient condition for natural monopoly. The proper condition was what mathematicians called ‘subadditivity’ of the cost function, meaning that a single firm could produce a given output more cheaply than any collection of smaller firms. The significance of this result was that one could not judge from local information alone whether an industry was a natural monopoly. Usually, information on costs of production was available in a small neighbourhood of the average output combination actually produced in the recent past, and this was quite sufficient to determine whether local scale economies were present, i.e. whether marginal costs were lower than average costs. But in order to test for sub additivity, it was necessary to estimate the cost function also at points far from actual output levels, e.g. at points corresponding to a 75 per cent cut in output.