University of California Transportation Center

When a firm or public authority prices output at marginal cost, its profits are related to the degree of local economies of scale in its cost function. As is well known, this result extends to the case where some congestion-prone inputs are supplied by users. I show that contrary to common belief, the result holds even when scale economies are affected by a rising factor supply curve. In that case, constant returns to scale in production produces diseconomies of scale in the cost function, making marginal-cost pricing profitable. Examples are provided for a monopsonist both with and without price discrimination. In the latter case, second-best pricing is also considered: profits then are not governed in the usual way either by returns to scale in production or by scale economies in the cost function, but some useful bounds are provided.