Cross Subsidies in Public Services: Some Issues

Pricing policy recommendations infrastructure services are based on two principles. One is that prices should cover the total cost of the service. The other is that cross subsidy schemes should be avoided. This technical paper explores the economic literature for rules on applying these principles to real world infrastructure services. The discussion is based on a partial equilibrium approach that uses market surplus as a proxy for social welfare and efficiency. Three main conclusions are reached in this paper. First, if a uniform price schedule is established and prices diverge from marginal cost, then social welfare can be increased by establishing appropriate price discrimination schemes that have cross subsidies. Second, from a voluntary sustainability standpoint, some cross subsidy schemes are not suitable, whereas others are appropriate. Third, sometimes, optimal and voluntary sustainable price schedules are not compatible. In these cases, a trade-off between optimality and sustainability is often necessary.