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Economies of scale and firm size optimum in rural water supply
Author(s) -
Sauer Johannes
Publication year - 2005
Publication title -
water resources research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.863
H-Index - 217
eISSN - 1944-7973
pISSN - 0043-1397
DOI - 10.1029/2005wr004127
Subject(s) - inefficiency , flexibility (engineering) , economies of scale , econometrics , water supply , scale (ratio) , production (economics) , curvature , returns to scale , economics , function (biology) , set (abstract data type) , sample (material) , microeconomics , environmental economics , business , industrial organization , environmental science , mathematics , computer science , environmental engineering , geography , cartography , management , geometry , evolutionary biology , programming language , biology , chemistry , chromatography
This article is focused on modeling and analyzing the cost structure of water‐supplying companies. A cross‐sectional data set was collected with respect to water firms in rural areas of former East and West Germany. The empirical data are analyzed by applying a symmetric generalized McFadden (SGM) functional form. This flexible functional form allows for testing the concavity required by microeconomic theory as well as the global imposition of such curvature restrictions without any loss of flexibility. The original specification of the SGM cost function is modified to incorporate fixed factors of water production and supply as, for example, groundwater intake or the number of connections supplied. The estimated flexible and global curvature correct cost function is then used to derive scale elasticities as well as the optimal firm size. The results show that no water supplier in the sample produces at constant returns to scale. The optimal firm size was found to be on average about three times larger than the existing one. These findings deliver evidence for the hypothesis that the legally set supplying areas, oriented at public administrative criteria as well as local characteristics of water resources, are economically inefficient. Hence structural inefficiency in the rural water sector is confirmed to be policy induced.