Most of the economics nowadays argue that the equality of the price of a good or a service with its marginal cost is a key condition to ensure the efficiency of allocation of resources (Hall, 1986). The ultimate goal of this pricing rule is the maximisation of social welfare. If the pricing rule mentioned above is not applied, we can examine two different cases. If the marginal cost of a good is below its price, it should be necessary to decrease the price so as to maximise social welfare. By contrast, if marginal cost is above its price, social welfare could be satisfied by raising the price. The pricing rule described above can be illustrated in Figure 1, where P represents the price of the product, Q the quantity and MC the marginal cost
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This is usual in the transportation sector as well because it is characterised by many distortions. In contrast with pricing in the first-best world, this has usually as a result welfare losses (Runhaar, 2001). As Lipsey and Lancaster (1956) state, if at least one of the Paretian optimum conditions cannot be attained, then the optimum situation is that of the second-best optimum. That is, if at least an input’s price does not equal its marginal cost, then the optimal price is in a second-best …show more content…
According to Gómez-Ibáñez (1999), this is because “transportation services often exhibit economies of scale so that marginal cost pricing does not generate enough revenues to cover costs”.
For a multi-product firm, which seeks to maximise its profits, if the marginal cost pricing rule is applied, it may lead to the firm losing money (Train, 1991). There are many different pricing options. However, a way to handle this issue is a technique known as Ramsey pricing (Gómez-Ibáñez, 1999). Ramsey pricing aims to minimise the welfare loss caused by deviating from marginal cost pricing. This pricing technique results in the smallest loss of consumer surplus. It provides the highest total surplus and gives the firm the possibility to break-even (Train, 1991). However, some economists disapprove it because it has a lot of limitations and poses some problems. For example, some customers with inelastic demand, who are charged at a high price, look for alternatives. However, despite those difficulties, Ramsey pricing is widely used in transportation services.
According to Nicholson and Snyder (2008), if we have the functions: P=P(Q) and TC=c(Q)
Subject to the
This is usual in the transportation sector as well because it is characterised by many distortions. In contrast with pricing in the first-best world, this has usually as a result welfare losses (Runhaar, 2001). As Lipsey and Lancaster (1956) state, if at least one of the Paretian optimum conditions cannot be attained, then the optimum situation is that of the second-best optimum. That is, if at least an input’s price does not equal its marginal cost, then the optimal price is in a second-best …show more content…
According to Gómez-Ibáñez (1999), this is because “transportation services often exhibit economies of scale so that marginal cost pricing does not generate enough revenues to cover costs”.
For a multi-product firm, which seeks to maximise its profits, if the marginal cost pricing rule is applied, it may lead to the firm losing money (Train, 1991). There are many different pricing options. However, a way to handle this issue is a technique known as Ramsey pricing (Gómez-Ibáñez, 1999). Ramsey pricing aims to minimise the welfare loss caused by deviating from marginal cost pricing. This pricing technique results in the smallest loss of consumer surplus. It provides the highest total surplus and gives the firm the possibility to break-even (Train, 1991). However, some economists disapprove it because it has a lot of limitations and poses some problems. For example, some customers with inelastic demand, who are charged at a high price, look for alternatives. However, despite those difficulties, Ramsey pricing is widely used in transportation services.
According to Nicholson and Snyder (2008), if we have the functions: P=P(Q) and TC=c(Q)
Subject to the