Financing Deficits

It has long been recognised that enterprises charging prices equal to marginal costs might make financial deficits. This can occur, assuming a stable price level, and that the enterprise is built from scratch, if the production function exhibits increasing or constant returns to scale. In the constant-returns-to-scale case it is necessary that the enterprise should employ inputs which are subject to significant indivisibilities and that at the optimal capacity level a price equal to short-run marginal cost should be less than long-run marginal cost. The increasing-returns-to-scale case encompasses the classic market-failure case of the bridge, the demand curve for whose services lies at all points below the average total cost curve.