Public Finance, 2nd Edition

The consumers may then be charged their demand prices (Lindahl prices) at

the chosen quantity, but this is not necessary. Any lump-sum tax preserves

pareto optimality.

In conclusion, the nonrivalry quality that ``any one person's consump-

tion does not diminish the quantity available to anyone else'' is not precise

enough to be useful. It could refer to a nonexclusive good or it could imply

nothing more than zero marginal costs (MRT). To avoid this ambiguity, we

believe the term ``public good'' should be reserved for instances of pervasive

externalities, more or less as Samuelson originally intended. If the term is also

used to characterize zero marginal cost, decreasing cost services, it loses its

particular analytical signiWcance. It might as well refer to any good requiring

government intervention, since there is no analytical reason to distinguish

between zero and nonzero marginal cost, decreasing cost services.

REFLECTIONS ON U.S. POLICY REGARDING DECREASING

COST SERVICES: THE PUBLIC INTEREST IN EQUITY

AND EFFICIENCY

Suppose a decreasing cost service satisWes the requirements of the ``easy

case,'' that a proWt-maximizing monopolist could at least break even. The

easy case presents three obvious pricing options for the government, each

depicted in Fig. 9.20.

0

X

$

P

MC

D

MR

MC

AC

P

AC

P

m

X

m

X

AC

X

opt

FIGURE 9.20

9. THE THEORY OF DECREASING COST PRODUCTION 297

The simplest option is to preserve free enterprise, oVer the natural

monopoly to private investors, and let them operate the service as a monopol-

ist. The expectation is that the owners will choose to maximize proWts by

producing output X

m

at which MR  MC, setting price equal to P

m

, and

earning pure proWts of (P

m

 AC)  X

m

.

The other two options involve government intervention, either in the

form of a direct government takeover of the service or private ownership with

government regulation. In either case, the government has two natural

choices:

1. Follow the dictates of Wrst-best theory, charge the marginal cost price

P

MC

, and subsidize the operation out of general tax revenues in the

amount of (AC  MC)  X

opt

.

2. Charge a price equal to average costs, P

AC

, and produce X

AC

,in

which case the service covers its full costs.

United States governments at all levels have overwhelmingly adopted the

average cost pricing strategy, or some close approximation to it, whether the

service is publicly or privately owned. For example, fees for recreational

facilities such as beaches and parks are usually set to cover the full costs of

operating these facilities. Tolls on urban highways, bridges, and tunnels are

often designed to cover the full costs of the entire network of transportation

facilities under the jurisdiction of a local transportation authority. The

federal gasoline tax was originally established to defray the expenses of

constructing the interstate highway system. Similarly, state gasoline tax

rates are determined primarily by the anticipated expenses of state highway

departments. Public utility rates are generally designed to cover all expenses

including a fair rate of return to the private investors. Admittedly, unless the

``fair return'' equals the opportunity cost of capital services, this is not strictly

average cost pricing, but its philosophy is more or less identical. One can

think of the utility regulatory commissions as constructing an average cost

curve that includes the ``fair'' rate of return and setting rates equal to these

constructed average costs.

In some instances, governments have not insisted on average cost pricing

for decreasing cost services. Examples include some national and state parks

and beaches Wnanced out of general revenues, over-the-air commercial tele-

vision Wnanced by advertising revenues, and sales of rights to use recorded

music through agencies such as ASCAP and BMI, which charge users a one-

time annual fee for access to their music inventories. Notice that in each of

these examples the per-use price of the service is essentially zero. Since the

marginal cost of these services is likely to be near zero, where the quantity axis

deWnes the number of users or viewers, the zero price can be thought of

as roughly consistent with optimal pricing (as long as the service remains

uncongested). The use of general revenues, advertising, or one-time fees to

cover costs may not be optimal, however.

298 THE PUBLIC INTEREST IN EQUITY AND EFFICIENCY