Public infrastructure capital, scale economies and returns to variety



(a - 1)(φx δ FF ) 0
D

(25)


(26)


nl ξ<φxδF F ) 0

Γ D

where D ≡ ξφ n - (a -1) 0.13

The provision of public capital attracts production factors into the production process of
intermediate goods. This has, as a consequence, an increase in the marginal cost of factor bundles (in
terms of consumption goods). The producers of intermediate goods would pass on this cost,
ceteris
paribus
, but only to the extent of their market power and in terms of a mark-up percentage). Holtz-
Eakin and Lovely observed that “
an increase in component prices must be accompanied by an
expansion in varieties if the economy is to retain a competitor in finished manufactures
” (Holtz-
Eakin and Lovely 1996, p.113). Due to the mark-up, the intermediate goods industry will have profits
at the initial phase of the economy (the phase with
n varieties). These profits will generate entry of
new firms into the sector producing intermediate goods. As Holtz-Eakin and Lovely argue “
an
increase in public infrastructure increases the number of component producers and enhances any
external economies of the finished manufactures industry
” (ibid.).

From equation 4 the proportionate change in finished manufactured goods is:

M_ an+ x 0                                                        (27)

An increase in the number of the firms producing intermediate goods does not ensure an
expansion of the sector producing manufactured goods. It can also be seen in equation 16 that a
public capital increase which reduces the fixed costs (
F) will decrease the level of output of the

manufacturing sector that is maximising profits. If the solutions for n and x0 are substituted in the
above equation, the effect of
F on the manufacturing sector can be derived as:

A

n ) + aξφ F + (a - 1)δ G

D


(28)


M _ ξδ G (aφ x

A

F

The sign of the numerator of the right-hand side of equation 28 depends on the sign of quantity

A

aΦxn (as all the other terms are positive). If this quantity is positive then M will be positive. This
will be the case if:

13 This condition is necessary in order to have a positive price-output relation for the manufacturing sector. This
assumption restricts the analysis to the concave part of the production frontier for the consumption and manufactured
goods (for further analysis, see Holtz-Eakin and Lovely 1996, footnote 11).



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