Overview

The economic behavior of a public firm is among the oldest problems of welfare economics. The two main instances where a public firm is called for are the provision of a public good and that of a private good of which the production technology has increasing returns to scale (IRS). Those are cases of natural monopoly. On the economic theory of natural monopolies see Baumol, Panzar, and Willig [1982]; on the optimal provision of a public good see the historical review by Musgrave and Peacock [1958] and the theoretical survey of Milleron [1972]. In both cases, the only efficient organization of production utilizes a single production unit, yet it would be socially wasteful to let this unit be operated by a profit-maximizing monopolist. Thus, there exist the need for a regulated public firm and the compelling normative question of its pricing policy.

Even under decreasing returns to scale (DRS), the case for joint production frequently arises. The workers of a cooperative jointly own its machines, and the partners of a law firm share its patrons. They must choose an equitable scheme to share the fruits of their cooperation. Thus, the general discussion of a public firm involves an arbitrary technology; if it has decreasing returns, we mean that it is operated jointly by the agents with no possibility of duplication (there is a large implicit fixed cost to open a new production unit).