USER CHARGES and SALES by PUBLIC MONOPOLIES

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USER CHARGES and SALES by PUBLIC MONOPOLIES

• Know When to Use Them
• Their Advantages and Disadvantages
• How Much to Charge

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License Fees are not User Fees
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TWO KINDS of LICENSE FEES

• Those intended primarily to generate revenue for
  government - no monitoring or inspection
  required, applicants rarely denied -- e.g.,
  business licenses
• Those based on government authority to regulate
  certain activities -- usually intended to offset,
  partially or completely, the the cost of the
  activities involved

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USER CHARGES

• Are appropriate where governments provide private
  goods -- including most public monopolies
• Make the users recognize that provision of those
  service is not costless
• Promotes conservation and efficient use
• Provides signals to government as to the level
  and kinds of service to provide

Automatically matches burdens to Benefits received
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When to Use User Fees
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When to Use

• The good is both excludable and potentially
  exhaustible
• Lumpy goods are usually toll goods
• Monopoly supply is appropriate where toll goods
  are concerned
• Government provision may, therefore, be
  appropriate for toll goods
• Publicly provided toll goods that are prone to
  congestion are especially good candidates for
  user fees
• Any publicly-provided, excludable good that
  wouldnt otherwise be provided might also be a
  good candidate for user fees (under provision is
  better than no provision)

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Advantages of Making Users Pay

• Make the service to a degree self financing.
  Transparency
• User fees register and record public demand for
  service. Transparency
• Equity is enhanced when some users who wouldnt
  be liable for taxes pay. Fairness
• Citizens who dont value services dont have to
  pay for them. Fairness
• User fees correct price/cost signals to private
  users, often leading them to modify their
  behavior. Efficiency

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Drawbacks to Making Users Pay

• Not appropriate for some public or commons type
  goods (lumpy public goods are toll goods).
  Efficiency
• Not appropriate where public provision in
  intended to promote redistribution (the fact that
  some users are poor is not a good argument
  against User Charges). Fairness/Efficiency
• Not appropriate where too costly to collect.
  Efficiency
• Service providers and clients will usually oppose
  (they normally reduce service demands). Politics

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Pricing Philosophy

• The only economic function of price is to
  influence behavior But of course price can only
  have this effect on the buyers side only if
  bills do indeed depend on the volume and kind
  of purchases. For this reason, economists are
  avid meterers.
• Fred Kahn

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Pricing Guidelines

• Know what drives cost -- prices should reflect
  cost and its behavior
• Understand demand -- prices should reflect demand
  (willingness and ability to pay)
• Use multi-part tariffs where appropriate
• Practice inverse-elasticity pricing and price
  discrimination where feasible
• Guidelines apply to ALL government services that
  are sold to citizens

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What Price to Charge Users

• The fundamental pricing rule
• How to price discriminate

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The fundamental pricing rule

• Produce up to the point where MRMC,
• where MR P1-(1/e)
• For a price taker
• MR P1-(1/e) P, hence PMC
• For a price searcher MR MC implies
• P MC/1 - (1/e),
• hence (P- MC)/P 1/e
• And P/(P- MC) e

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The fundamental pricing rule
P/(P- MC) e
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(P-MC)/P 1/e

• The higher the elasticity, the lower the markup
  of price over marginal cost. The lower the
  elasticity, the higher the markup.
• (Elasticity tends to be higher when there are
  many competitors and substitutes.)

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QUESTION

• True or false the optimal price will always be
  on the elastic portion of the residual demand
  curve?

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QUESTION

• True.
• If e is less than 1, raising price will both
  increase revenue, and decrease costs.

• True or false the optimal price will always be
  on the elastic portion of the residual demand
  curve?

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QUESTION

• When will the optimal price be set where the e
  of the residual demand curve is 1

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QUESTION

• When will the optimal price be set where the e
  of the residual demand curve is 1

• If e is 1, MC must equal zero.
• P/P-MC e
• P/P- 0 1

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QUESTION Given a linear demand curve that
intersects the Y axis at a price of 10, and a
marginal cost of 2 per unit, what is the optimal
price?
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ANSWER P 6. 1/e (Pmax - P)/P (10 -
P)/P. (P - MC)/P (P-2)/P. Equating the right
side of the equation to the left, (10-P)/P (P
- 2)/P or (10 - P) (P - 2).
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Price discrimination

• Definition A single organization price
  discriminates when it charges different prices to
  different consumers that are not proportional to
  differences in marginal cost, i.e., when for two
  different consumers (1 2), p1/MC1 ? p2/MC2 (of
  course, MR1/MC1 MR2/MC2).

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Necessary conditions

• At least two consumer groups exist with different
  elasticities, i.e., different demand curves.
• The organization can identify consumers in each
  group, and set prices differently for consumers
  in the two groups.
• The organization must be able to prevent
  consumers in one group from selling to consumers
  in the other (no arbitrage).

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• Price discrimination
• Note P1 is 3 times MC P2 is twice MC.
• Solving for e (3 - 1)/3 1/e 1.5 (2 -
  1)/2 1/e 2.
• The more inelastic the demand, the higher the
  markup
• inverse elasticity pricing rule or, where subject
  to a revenue constraint, Ramsey optimal pricing.

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• Examples of price discrimination
• Senior citizen and childrens discounts offer
  lower prices to those with more elastic demands
  for municipal pools.
• Universities offer lower prices in the form of
  financial aid (need based aid) to those with
  higher elasticities of demand (note it is easier
  to discriminate where services are concerned than
  where goods are concerned and where consumables
  are concerned than durables).
• Tying supplies to use of a durable piece of
  equipment, sometimes called Barbie Doll
  Marketing give away the dolls but charge a lot
  for the dresses.

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• One of the most effective price-discrimination
  mechanisms is the multi-part tariff.
• Multi-part tariffs decompose product/services to
  their fundamental attributes and charge users for
  their actual consumption of each.
• The best example of a multi-part tariff is your
  phone bill.
• Multi-part Ramsey-optimal tariffs are also
  commonly used in internal transfer pricing,
  initially for IT services, now more widely in
  intra-net based organizations

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Lotteries, State-Run Liquor Stores
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State Liquor Monopolies

• Voluntary and enjoyable approach to government
  finance
• Can be thought of a tax on addictive behavior
• Disproportionate quantities of alcohol are
  purchased by poor and ill-educated
• Receipts tend to increase over time they are
  very stable (which tends to reduce the volatility
  government income somewhat)

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LOTTERIES VIDEO POKER

• Voluntary and enjoyable approach to government
  finance
• Can be thought of a tax on statistical naiveté
  (addictive behavior)
• Disproportionate number of lottery tickets are
  purchased by poor and ill-educated
• Receipts tend to decline over time they are also
  very volatile (however, their volatility tends to
  reduce the volatility government income somewhat)