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The Inefficiency of Marginal-Cost Pricing and The Apparent Rigidity of Prices

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  • Robert E. Hall

Abstract

Under conditions of natural monopoly, private contracts or government regulation may attempt to avoid inefficiency by setting up a pricing formula. Once the capital stock is chosen,the right price to charge the buyer is marginal cost. But the point of this paper is that marginal-cost pricing provides the wrong incentives for the choice of the capital stock by the seller. If the seller can achieve a high price by deliberately under-investing and driving up marginal cost, there will be asystematic tendency toward too small a capital stock. One type of contract or regulatory policy that avoids this problem charges marginal cost to each buyer, but provides a revenue to the seller that is equal to long-run unit cost, not short-run marginal cost. Such a contract or policy will make the price, in the sense of the revenue of the seller per unit of output, appear to be unresponsive to market conditions.

Suggested Citation

  • Robert E. Hall, 1984. "The Inefficiency of Marginal-Cost Pricing and The Apparent Rigidity of Prices," NBER Working Papers 1347, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1347
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    Cited by:

    1. Hubbard, R Glenn & Weiner, Robert J, 1992. "Long-Term Contracting and Multiple-Price Systems," The Journal of Business, University of Chicago Press, vol. 65(2), pages 177-198, April.

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