The Theory of Public Utility Pricing and Its Application
Volume: Volume 1, No. 1
Issue: Spring 1970
Pages: pp. 113-128
Authors: Ronald H. Coase
Title: The Theory of Public Utility Pricing and Its Application
Abstract: In the 1930's and 1940's, the view came to be held that the right policy was to make public utility prices everywhere equal to marginal cost, even where marginal cost was less than average cost and a government subsidy was required to maintain production. This policy proposal had serious weaknesses. It did not take into account the stimulus to correct forecasting of having a subsequent market test whether consumers were willing to pay the total cost; it ignored the probably effects on the administrative structure, with state enterprise and centralized operations superceding decentralized operations; it involved a redistribution of income in favor of consumers of products produced in conditions of decreasing costs; it failed to take into account the misallocation of resources resulting from the additional taxation necessitated by the subsidies.
When appraising a policy proposal, it is necessary to discover its total effect. There is a growing realization among economists that this is the correct approach, and it may be that today what advocates of marginal cost pricing have in mind is that the advantages of making price equal to marginal cost should be taken into account -- a position with which there would be general agreement. But if prices are not to equal marginal cost, the question of what the structure of rates should be needs to be examined. The treatment of this subject has not gone very far. But this should not obscure the agreement which exists among economists as to how costs should be calculated (which is very different from the way regulatory commissions view costs). The implications of this difference in approach for price determination may be illustrated by examining the situation created by the FCC's "Above 890-megacycle" decision, which exposed the common carriers to expanded competition from private microwave systems, and the response of the AT&T Company introducing the TELPAKreg. Service.