Introduction

Our purpose in this chapter is to gain an understanding of the problems that arise in choosing ideal prices and to see how welfare economics can help solve them. We use both consumer surplus and individual utility measures of welfare, and very simple representations of cost. The cases that we consider here almost always yield an ideal price, in the sense that users pay the marginal costs that follow from their decisions. If for some reason the process of competition is not to be relied on and if cost-minimizing actions can be induced without it, whatever institution replaces competition can find ideal guidance in the solutions of this chapter. Just what institution might play this role, and to what extent it could be induced to pursue welfare, are questions we shall not pursue yet. Our aim here is to identify ideal prices, not to implement them. Even apart from implementation, the welfare-maximizing prices of this chapter ignore realities such as budget constraints that lead to second-best pricing.

Second-best pricing is considered in Chapters 5 and 6. Chapter 5 deals with a problem that frequently arises in public utilities and public enterprises, where – because of technological conditions such as economies of scale or economies of scope – prices equal to marginal costs will not yield enough revenue to cover total cost. Chapter 6 considers effects of pricing on income distribution. Let us briefly explain why technology can prevent the ideal (P = mc) solutions of this chapter from serving satisfactorily and can make further study in Chapters 5 and 6 necessary.