In this chapter we bring together the demand side and the cost structure of the regulated firm to start on our main theme: efficient pricing by the regulated firm for its services. The discussion is designed to bring out the main concepts as clearly as possible. These concepts are:
This book aims to make recent developments in public utility pricing theory accessible to the non-technical reader and to show how they can be usefully applied to major policy issues in ratemaking. Several policy issues have arisen within the last fifteen years or so which cannot be analyzed correctly without these developments. The classic treatise of Kahn [1970], although offering a wealth of institutional detail and breadth which we cannot match, summarizes the relevant economic theory at a point in time just short of a series of major advances which began to take place shortly after the appearance of Kahn's book. It is useful to sketch the policy issues and the research advances to which they led.
In the previous chapter we developed the major theme of second-best pricing: to cover total costs of the regulated firm with minimum deadweight loss. The term Ramsey prices was used to refer to the set of uniform prices which maximize total surplus - minimizing deadweight loss - subject to the breakeven constraint. Ramsey prices do this by charging different prices to the regulated firm's various markets with the aim of generating the largest amounts of contribution from markets in which a high markup of price over marginal cost will perturb consumption levels least from what would be achieved with full marginal cost pricing. In this chapter we will broaden the analysis to include price structures which permit us to vary prices not only between markets, but also between consumers in the same market.
Courts have struggled with determining when bundled discounts constitute unlawfully anticompetitive behavior. The current circuit split reflects an absence of consensus. This lack of legal guidance creates uncertainty in the market, with firms being given inconsistent – and sometimes contradictory standards on how to avoid antitrust liability. For the most part, we consider a standard paradigm for analyzing bundled discounts. Suppose that there are two firms. Firm 1 produces a monopoly product, A, and also another product, B, which competes with another version of B produced by Firm 2. The concern is the extent to which the price paid for A is linked to the purchase of B from Firm 1: has the bundling resulted in anticompetitive conduct in violation of Section 2 of the Sherman Act? We analyze three main approaches: the discount attribution test, the Elhauge proposal, and the Profit Sacrifice Test. Each of these has received much recent discussion, but very little of the debate takes into account the effects of bundled discounts where all firms are setting prices that maximize profits, i.e. in equilibrium. . With homogeneous goods in the B market, the attribution test should be failed is all firms are maximizing profits. The Elhauge proposal makes sense with equilibrium prices in some types of markets, but not others. The profit sacrifice test turns out to be vacuous when applied to bundled discounts, since in equilibrium there turns out to be no profit sacrifice. i. We explore related issues with tying arrangements. * The John Michael Stuart Centennial Professor of Economics at the University of Texas at Austin. Ph.D. (Economics) Yale University; B.A. (Economics) Stanford University. The author thanks Keith Hylton, Padmanbhan Srinagesh, David Radlauer, Michael Doane and, especially, Einer Elhauge and Patrick Greenlee for helpful discussions on the issues herein and, most particularly, his wife for assistance and patience over many years. ** Competition Economics, LLC. B.S.E.E. Tufts University. *** Professor & Chair, Department of Business Law, California State University, Northridge. J.D., Boston University; B.A., University of California.
