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This study made an analysis of components of production costs of Palestinian industries. Also, a Second Order Translog Cost Function was estimated by using the ordinary least squares. Results of the study revealed that the raw materials had the biggest share in production cost (72%) followed by labor cost (21%). It was also found that large firms had benefited from economies of scale more than small firms. Generally, the Palestinian industries enjoyed economies of scale as well as increasing returns to scales. However, it was found that some industrial sectors had reached a stage of diseconomies of scales. This is an indication that some Palestinian firms did not work effectively, and failed to reach the optimal plant size. Based on these findings, we can say that improving productivity is the basic source to improve Palestinian industries’ competitiveness. Therefore, there is a need to provide incentives for projects enjoying economies of scale to expand internally or by merger. Further, there is a need for setting up of government programs to explain the importance of merger among small firms and promote it. Finally, there is a need for reconsidering the policy of industrial firm licensing applied now because it doesn’t give enough attention to the degree of scale economies and returns to scale upon granting licensing.