IDEAS home Printed from https://ideas.repec.org/p/oxf/wpaper/102.html
   My bibliography  Save this paper

Marginal Cost Pricing versus Insurance

Author

Listed:
  • Simon GB Cowan
  • Simon Cowan

Abstract

The regulator of a natural monopoly that sets a two-part tariff and whose marginal cost is stochastic will generally want the price to vary less than marginal cost when the lump-sum charge in the tariff is fixed. A trade-off exists between efficient pricing and an optimal allocation of risk. Pricing at marginal cost is only optimal when the consumer`s marginal utility is independent of the price. When marginal utility increases with the price the mark-up falls monotonically as marginal cost rises. The lump-sum element of the tariff should exceed the fixed cost when demand is inelastic and equals the fixed cost only with unit elasticity. The model may also be applied to optimal commodity taxation.

Suggested Citation

  • Simon GB Cowan & Simon Cowan, 2002. "Marginal Cost Pricing versus Insurance," Economics Series Working Papers 102, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:102
    as

    Download full text from publisher

    File URL: https://ora.ox.ac.uk/objects/uuid:036a0572-5804-45ed-8c46-620690f8cb7e
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Dhillon, Upinder S & Shilling, James D & Sirmans, C F, 1987. "Choosing between Fixed and Adjustable Rate Mortgages: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(2), pages 260-267, May.
    2. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(4), pages 1449-1494.
    3. Giuliano, Paola & Turnovsky, Stephen J., 2003. "Intertemporal substitution, risk aversion, and economic performance in a stochastically growing open economy," Journal of International Money and Finance, Elsevier, vol. 22(4), pages 529-556, August.
    4. Gilbert, Christopher L, 1985. "Futures Trading and the Welfare Evaluation of Commodity Price Stabilisation," Economic Journal, Royal Economic Society, vol. 95(379), pages 637-661, September.
    5. George M. Constantinides & John B. Donaldson & Rajnish Mehra, 2002. "Junior Can't Borrow: A New Perspective on the Equity Premium Puzzle," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(1), pages 269-296.
    6. Myles,Gareth D., 1995. "Public Economics," Cambridge Books, Cambridge University Press, number 9780521497695, September.
    7. Newbery, David M, 1989. "The Theory of Food Price Stabilisation," Economic Journal, Royal Economic Society, vol. 99(398), pages 1065-1082, December.
    8. Severin Borenstein, 2002. "The Trouble With Electricity Markets: Understanding California's Restructuring Disaster," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 191-211, Winter.
    9. Turnovsky, Stephen J & Shalit, Haim & Schmitz, Andrew, 1980. "Consumer's Surplus, Price Instability, and Consumer Welfare," Econometrica, Econometric Society, vol. 48(1), pages 135-152, January.
    10. Britto, Ronald, 1980. "Resource Allocation in a Simple, Two-Sector Model with Production Risk," Economic Journal, Royal Economic Society, vol. 90(358), pages 363-370, June.
    11. Rogerson, William P, 1980. "Aggregate Expected Consumer Surplus as a Welfare Index with an Application to Price Stabilization," Econometrica, Econometric Society, vol. 48(2), pages 423-436, March.
    12. Barzel, Yoram & Suen, Wing, 1992. "The Demand Curves for Giffen Goods Are Downward Sloping," Economic Journal, Royal Economic Society, vol. 102(413), pages 896-905, July.
    13. Stennek, Johan, 1999. "The expected consumer's surplus as a welfare measure," Journal of Public Economics, Elsevier, vol. 73(2), pages 265-288, August.
    14. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, April.
    15. Besley, Timothy J, 1989. "A Definition of Luxury and Necessity for Cardinal Utility Functions," Economic Journal, Royal Economic Society, vol. 99(397), pages 844-849, September.
    16. Crew, Michael A & Fernando, Chitru S & Kleindorfer, Paul R, 1995. "The Theory of Peak-Load Pricing: A Survey," Journal of Regulatory Economics, Springer, vol. 8(3), pages 215-248, November.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Simon Cowan, 2004. "Utility Regulation and Risk Allocation: The Roles of Marginal Cost Pricing and Futures Markets," Journal of Regulatory Economics, Springer, vol. 26(1), pages 23-40, July.
    2. Simon GB Cowan & Simon Cowan, 2002. "Commodity Taxation as Insurance Against Price Risk," Economics Series Working Papers 110, University of Oxford, Department of Economics.
    3. Cowan, Simon, 2004. "Optimal risk allocation for regulated monopolies and consumers," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 285-303, January.
    4. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    5. Charles Blackorby & David Donaldson & John A. Weymark, 2008. "Hicksian Surplus Measures of Individual Welfare Change When There is Price and Income Uncertainty," Studies in Choice and Welfare, in: Prasanta K. Pattanaik & Koichi Tadenuma & Yongsheng Xu & Naoki Yoshihara (ed.), Rational Choice and Social Welfare, pages 195-213, Springer.
    6. Gouel, Christophe, 2013. "Optimal food price stabilisation policy," European Economic Review, Elsevier, vol. 57(C), pages 118-134.
    7. Kim, Tae-Kyun, 1989. "The factor bias of technical change and technology adoption under uncertainty," ISU General Staff Papers 1989010108000010138, Iowa State University, Department of Economics.
    8. Dancsik, Bálint, 2017. "Számít-e a devizahiteles múlt?. A lakáshitelkamatok rögzítéséről szóló döntés vizsgálata mikroszintű adatokon [Analysing the decision of fixing housing loan interest rates on micro-level data: does," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(10), pages 1030-1055.
    9. Herter, Karen & Wayland, Seth, 2010. "Residential response to critical-peak pricing of electricity: California evidence," Energy, Elsevier, vol. 35(4), pages 1561-1567.
    10. Matthew Chambers & Carlos Garriga & Don E. Schlagenhauf, 2007. "Equilibrium mortgage choice and housing tenure decisions with refinancing," Working Papers 2007-049, Federal Reserve Bank of St. Louis.
    11. Agarwal, Sumit & Ambrose, Brent W. & Chomsisengphet, Souphala & Liu, Chunlin, 2006. "An empirical analysis of home equity loan and line performance," Journal of Financial Intermediation, Elsevier, vol. 15(4), pages 444-469, October.
    12. D. Duffy & M.J. Roche, 2005. "Heterogeneous Homebuyers, Mortgage Choice and the use of Mortgage Brokers," Economics Department Working Paper Series n1520205, Department of Economics, National University of Ireland - Maynooth.
    13. Christophe Gouel, 2014. "Food Price Volatility and Domestic Stabilization Policies in Developing Countries," NBER Chapters, in: The Economics of Food Price Volatility, pages 261-306, National Bureau of Economic Research, Inc.
    14. Philomena M. Bacon & Peter G. Moffatt, 2012. "Mortgage Choice as a Natural Field Experiment on Choice under Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1401-1426, October.
    15. Svenstrup, Mikkel, 2002. "Mortgage Choice - The Danish Case," Finance Working Papers 02-22, University of Aarhus, Aarhus School of Business, Department of Business Studies.
    16. Ehrmann, Michael & Ziegelmeyer, Michael, 2014. "Household Risk Management and Actual Mortgage Choice in the Euro Area," MEA discussion paper series 201406, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    17. Choné, Philippe & Linnemer, Laurent, 2008. "Assessing horizontal mergers under uncertain efficiency gains," International Journal of Industrial Organization, Elsevier, vol. 26(4), pages 913-929, July.
    18. Matt Chambers & Carlos Garriga & Don Schlagenhauf, 2009. "The Loan Structure and Housing Tenure Decisions in an Equilibrium Model of Mortgage Choice," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 444-468, July.
    19. Rosellón, Juan & Myslíková, Zdenka & Zenón, Eric, 2011. "Incentives for transmission investment in the PJM electricity market: FTRs or regulation (or both?)," Utilities Policy, Elsevier, vol. 19(1), pages 3-13, January.
    20. Elsa Fornero & Chiara Monticone & Serena Trucchi, 2011. "The effect of financial literacy on mortgage choices," CeRP Working Papers 121, Center for Research on Pensions and Welfare Policies, Turin (Italy).

    More about this item

    Keywords

    price risk; regulation; Ramsey pricing;
    All these keywords.

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oxf:wpaper:102. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Anne Pouliquen (email available below). General contact details of provider: https://edirc.repec.org/data/sfeixuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.