Chapter 25 Positive second-best theory : A brief survey of the theory of ramsey pricing

This chapter surveys issues in positive second-best theory, specifically the theory of the optimal pricing of goods produced by public firmsthat is, firms whose objective is the maximization of social welfare. It is assumed that these firms, characteristically, display increasing returns to scale. In these situations, first-best optima may require lump-sum taxes and subsidies. In view of the size of the public sector in most industrialized countries, it is difficult to imagine that public activities can be financed without distortionary effects elsewhere in the economy. The chapter assumes perfect possibilities for lump-sum income transfers to focus on the efficiency aspect of optimal pricing. If lump-sum redistribution is impossible, deviations from marginal costs for prices under public control may be motivated by distributional considerationsthat is, the government may want to use its excise tax power to improve the income distribution. The chapter provides general formulation that forms a basis for special cases that are analyzed in more detail subsequently. It also discusses the joint decision for the optimal supply of public goods and the pricing problem. Finally, it analyzes some issues in predation and Ramsey pricing in a dynamic context.