Hence the need to consider optimal departures from marginal cost pricing, analysing how the final outcomes can be influenced by information and instruments available both to the firms and to the regulator. Sorry, we are unable to provide the full text but you may find it at the following locations. Similar problems arise under nonlinear twopart pricing of transmission and distribution assets. This site is part of repec and all the data displayed here is part of the repec data set. Marginalcost pricing, in economics, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. Section 5 discusses the causes and consequences of the current rate structure with emphasis on implications for carbon policy. Optimal reversepricing mechanisms marketing science 296, pp. One possible starting point is the cost of each item for sale. When does marginal cost pricing lead to pareto efficiency.
Increasing returns are also prevalent in the real economy. Discussion and an application to swedish airports fredrik carlssona working papers in economics no. Averagecost pricing, increasing returns, and optimal output in a model with home and market production the issue of increasing returns is one of those that will be raised incessantly as a neat general solution is lacking and many different outcomes are possible. An overview of the discussion, the bell journal of economics and management.
It is well known that first best marginal cost pricing by a natural monopoly. They examine the proposition that in order to reach the optimal point of allocating resources, prices that deviate from marginal cost are required. When this marginal revenue information is combined with pertinent marginal cost data, the basis for an optimal pricing policy is created. Efficiency and equity considerations in pricing and allocating irrigation water, policy research working paper series 1460, the world bank. For the results which it describes have appeared many times in the. The theory of water and utility pricing springerlink. In this specification, marginal and average costs are equal, so no ambiguity arises with respect to which cost is involved in pricing. Furthermore, since consumers are assumed to shift part of their income to other commodities as a response to higher water prices, the marginal. Suboptimal generation portfolio variance with rate of. Marginal cost pricing, in economics, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. Marginal cost pricing is the practice of setting the price of a product at or slightly above the variable cost to produce it.
Historical perspectives on competition and interconnection. Suboptimal generation portfolio variance with rate of return. Bradford in their article optimal departures from marginal cost pricing also discuss the price distortion taxes cause. Consequently, the optimal pricing rule can deviate from the marginal. Sep 23, 2014 baumol w, bradford d 1970 optimal departures from marginal cost pricing. Optimal departures from marginal cost prices for local public. A competitive firm equates its marginal cost to the market price of its. This situation usually arises in either of the following circumstances. Optimal departures from marginal cost pricing econpapers. Optimal departures from marginal cost prices for local. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labor. The social welfare function used is typically a function of individuals utilities, most commonly some form of utilitarian function, so the tax system is chosen to maximise the aggregate of individual utilities. Marginal costs secondbest ramsey pricing translog multiproduct cost function. I introduce the secondbest pricing scheme, derive conditions for the marginal cost pricing and inverseelasticity rules to apply, and analyze when it is optimal for the government to optimally deviate from these two pricing schemes.
The need for this paper is a paradox in itself and indeed. Section 6 compares regulated prices for municipally owned and investorowned distribution companies, and section 7. There are several ways to measure the costs of production, and some of these costs are related in interesting ways. Results in terms of social welfare, distribution of optimal fares, and optimal frequency of service can be used as a benchmark for the analysis of other pricing policies such as. The relation between marginal revenue, price, and the point price elasticity of demand follows directly from the mathematical definition of a marginal relation. Differentiating the marginal cost pricing rule, we obtain, since effort is maximal at the optimum, that qm q. Information needed to price payments and problems in implementation 12 information needed 12. Phase iv, finally, brings wide departures from neoclassical welfare theory, putting. Citations of optimal departures from marginal cost pricing. When water is abundant, the revenue constraint dictates the prices, resulting in a higher price for the less elastic demand. Nov 11, 2018 the relationship between average and marginal cost can be easily explained via a simple analogy.
The welfare effects of different pricing schemes for electricity distribution in finland, energy policy, elsevier, vol. Structure of electricity distribution network tariffs. Marginal cost and secondbest pricing for water services. Bradiford the need for this paper is a paradox in itself and indeed it might be subtitled. Pricing at marginal cost is only optimal when the consumers marginal utility is independent of the price. Baumol w, bradford d 1970 optimal departures from marginal cost pricing. The marginal cost controversy in intellectual property. David frantz bradford january 8, 1939 february 22, 2005 was a prominent american economist and professor of economics and public affairs in the woodrow wilson school at princeton university bradford was born in cambridge, massachusetts. Rather than think about costs, think about grades on a series of exams. The purloined proposition or the mystery of the mislaid maxim. Average cost pricing versus marginal cost pricing under. A tradeoff exists between efficient pricing and an optimal allocation of risk. Conditions for optimal bus fares that increase or decrease as a function of trip length are numerically found.
Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that maximises a social welfare function subject to economic constraints. The coefficient of proportionality is related to the lagrange multiplier of the budget constraint which itself depends on both demand functions and cost. Optimal departures from the inverse elasticity rule i consider the problem of water usage, developing a model to analyze the optimal pricing of water. Yet, economic theory also identifies a host of conditions, under which marginal cost pricing is neither feasible nor optimal. Averagecost pricing, increasing returns, and optimal output. Price elasticity and optimal pricing policy in managerial. As a result, if all network tariffs were set at lrmc, the distribution network service providers dnsps would not recover the total authorised cost of the network. The new economics of regulation ten years after authors. After his graduation from amherst college in 1960, bradford studied at mit and harvard m. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labour. Bradford 1970 optimal departures from marginal cost pricing,american. This approach typically relates to shortterm price setting situations. Consequently, the optimal pricing rule can deviate from the marginalcost pricing or the inverseelasticity rules.
Pricing products is a difficult but essential part of running a business. Baumol with alvin klevorick, input choices and rate of return regulation. Averagecost pricing, increasing returns, and optimal. Note that by duality, the production and cost elasticities in 1 and 2 are identical. For example optimal departures from marginal cost pricing must be, in the simple case of separable utility functions without income effects, simply inversely proportional to price elasticities. Baumol and david f bradford, optimal departures from marginal cost pricing, 60 am econ rev 265,265 1970 emphasis removed. The relationship between average and marginal costs. Optimal departures from marginal cost pricing by william j. Businesses often set prices close to marginal cost during periods of poor sales. When the perunit price is set at marginal cost, with increasing decreasing marginal cost, customers will choose a more less risky generation portfolio than they. I introduce the secondbest pricing scheme, derive conditions for the marginalcost pricing and inverseelasticity rules to apply, and analyze when it is optimal for the government to optimally deviate from these two pricing schemes. Consequently, the optimal pricing rule can deviate from the marginal cost pricing or the inverseelasticity rules. As a water supplier, the local government may price discriminate across consumers and farmers. Introduction kraus 2003 considered the secondbest policy problem that arises when auto travel is priced below its marginal cost and there is a substitute mass transit mode.
Optimal departures from the inverse elasticity rule, working paper series 1533, victoria university of wellington, school of economics and finance. David frantz bradford january 8, 1939 february 22, 2005 was a prominent american economist and professor of economics and public affairs in the woodrow wilson school at princeton university. Optimal departures from marginal cost prices for local public services in. The difficulty comes now from the divergence between the optimal production level q and the production level obtained with marginal cost pricing. Pdf we derive an optimal airportpricing model, both with and without a.
Optimal departures from marginal cost pricing nyu stern. In this specification, marginal and average costs are equal, so no ambiguity arises. Information needed to price payments and problems in implementation 12 information needed 12 problems in implementation 14 8. The price can be adjusted based on the cost the higher the price, the higher the profit margin on that item. I introduce the secondbest pricing scheme, derive conditions for the marginal cost pricing and inverseelasticity rules to apply, and analyze when it is optimal for the government to optimally. Optimal departures from marginal cost pricing created date. Optimal pricing of utility power purchases from qualifying.
The present paper revisits the problem, obtaining much stronger results in a richer model. A dynamic analysis of secondbest pricing springerlink. For example, average cost ac, also called average total cost, is the total cost divided by quantity produced. Optimal departures from marginal cost pricing jstor. Marginal cost pricing 9 optimal departure from marginal cost pricing 10 average cost, twopart, and benefitflow pricing 10 other pricing methods 11 6. The general version of ramsey pricing states that the quasioptimal prices. Pricing, cost recovery, and production efficiency in transport.
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