Review of Industrial Organization 18: 219–227, 2001.
© 2001 Kluwer Academic Publishers. Printed in the Netherlands.
Economies of Scale and Scope in Australian
HARRY BLOCH, GARY MADDEN
and SCOTT J. SAVAGE
Communications Economics Research Program, School of Economics and Finance, Curtin
University of Technology, Perth, Australia
Abstract. This paper employs a composite cost function to examine the cost structure of Australian
telephone services. The composite cost model combines the log-quadratic input price structure of the
translog model with a quadratic structure for multiple outputs. Quadratic output structures permit the
measurement of economies of scale, economies of scope, and subadditivity without prejudging their
presence. Model estimates, on Telstra system data from 1926 to 1991, show that the production of
Australian telephone services exhibits economies of scope but no ray economies of scale.
Key words: Telecommunications, production, scale, scope, Australia
Since the early part of this century the telephone industry has been organised as a
natural monopoly under the assumption that its cost structure is subadditive. When
a ﬁrm’s cost function is subadditive (for given input prices) it can produce an arbit-
rary output vector more cheaply than any two ﬁrms faced with same cost function
(Baumol and Braunstein, 1977). Subaddivity can arise from economies of scale
and/or economies of scope. However, economies of scale are neither necessary nor
sufﬁcient for subadditivity, while economies of scope are necessary. Economies of
scale exist when the marginal costs of production are less than ray average cost
over the relevant output range. Economies of scope exist when common facilities
make the production of a combination of goods less expensive then producing them
separately. As single ﬁrm production is the more cost effective in producing any
output mix, monopolistic ﬁrms are usually subject to price and entry regulation in
an attempt to achieve competitive outcomes (Berg and Tschirhart, 1995).
Corresponding author. GPO Box U1987, Perth, Australia, 6845; E-mail:
email@example.com Presented at the 1999 Conference of Economists, La Trobe University,
26–30 September, 1999. The authors acknowledge ﬁnancial support from the Australian Research
Council Large Grants Scheme, and data support from John de Ridder, Geoffrey Sims and Telstra.
Any opinions, ﬁndings or conclusions expressed in this paper are those of the authors and do not
reﬂect the views of the named institutions or individuals. Helpful comments from two anonymous
referees are gratefully acknowledged.