Competition, economies of scale, and diversity of firm sizes

This paper presents an empirical example in which small firms are able to compete by specializing, without monopolistic conduct, despite economies of scale. The viability of small commercial banks in Illinois is established both by casual observation and by a finding of constant returns to scale, not correcting for specialization. A second specification of the cost function, correcting for specialization, exhibits economies of scale, suggesting that specialization is the means by which small banks survive. Monopoly conduct is ruled out by a Rosse–Panzar test, rejecting the alternative hypothesis that monopoly power has allowed inefficient banks to survive.