Working Paper: NBER ID: w1347
Authors: Robert E. Hall
Abstract: Under conditions of natural monopoly, private contracts or government regulation may attempt to avoid inefficiency by setting up a pricing formula. Once the capital stock is chosen,the right price to charge the buyer is marginal cost. But the point of this paper is that marginal-cost pricing provides the wrong incentives for the choice of the capital stock by the seller. If the seller can achieve a high price by deliberately under-investing and driving up marginal cost, there will be asystematic tendency toward too small a capital stock. One type of contract or regulatory policy that avoids this problem charges marginal cost to each buyer, but provides a revenue to the seller that is equal to long-run unit cost, not short-run marginal cost. Such a contract or policy will make the price, in the sense of the revenue of the seller per unit of output, appear to be unresponsive to market conditions.
Keywords: marginal-cost pricing; natural monopoly; investment incentives; price rigidity
JEL Codes: D42; L12; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Marginal-cost pricing (D40) | Inefficiently low capital stock (E22) |
| Marginal-cost pricing (D40) | Disincentives for investment in capital stock (E22) |
| Disincentives for investment in capital stock (E22) | Inefficiently low capital stock (E22) |
| Contracts/regulatory policies (G18) | Align incentives for capital accumulation (E22) |
| Align incentives for capital accumulation (E22) | Capital efficiency (G31) |