Public Finance, 2nd Edition

21

DECREASING COSTS AND THE

THEORY OF THE SECOND-BESTÐ

THE BOITEUX PROBLEM

THE BOITEUX PROBLEM: THE MULTIPRODUCT DECREASING-

COST FIRM

Analytics of the Boiteux Problem

Public Agencies and Private Markets

The U.S. Postal Service

CONSTRAINED GOVERNMENT AGENCIES

Chapter 9 developed the three Wrst-best decision rules for decreasing cost

services:

1. A decreasing cost industry is a natural monopoly. It should consist of a

single Wrm to minimize the total cost of producing any given output.

2. Price must equal marginal cost for pareto optimality. Achieving this

result requires either government regulation or government provision of the

service, since a proWt-maximizing monopolist would presumably set marginal

revenue equal to marginal cost.

3. Marginal-cost pricing implies operating losses with decreasing unit costs.

Therefore, the government must subsidize the Wrm's losses with a lump-sum

transfer so that the investors can earn a return equal to the opportunity cost of

capital. This transfer simply becomes part of the Wrst-best interpersonal equity

conditions for optimal income distribution. That is, in satisfying interpersonal

equity, the government must collect enough taxes from one subset of con-

sumers to subsidize all decreasing cost producers as well as provide transfers to

the remaining subset of consumers.

1

1

A Wnal point common to all Wrst-best expenditure theory is that the government should

allow competitive allocations in all other nondecreasing cost markets. The simple model of

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