Economics Dictionary of ArgumentsHome
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| Decreasing-cost industries: Decreasing-cost industries are those where average costs decline as industry output increases. This occurs due to external economies of scale, such as improved infrastructure or supplier networks. As the industry grows, firms benefit from lower input costs, enhancing overall efficiency and competitiveness. Examples include technology and some manufacturing sectors. See also Costs, Production cost, Production, Production structure._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Ronald Coase on Decreasing-Cost Industries - Dictionary of Arguments
Kiesling I 46 Decreasing-cost industries/marginal cost controversy/Coase /Kiesling: In 1938 Harold Hotelling(1) published an argument in favour of marginal cost pricing on efficiency grounds, based on the general argument that social welfare is maximized where marginal benefit equals marginal cost. For that reason, Hotelling argued, these firms should charge consumers a price equal to marginal cost and receive taxpayer-funded subsidies to cover their fixed costs (which, again, are considerable). Hotelling relied on taxation theories to suggest lump-sum taxes on consumers that, in aggregate, would pay for fixed costs. >Marginal costs, >Efficiency, >Taxation. Coase: In 1946 Coase’s analysis of Hotelling’s proposal, “The Marginal Cost Controversy,”(2) clarified the question and gave the debate its name. (Frischmann and Hogendorn (2015)(3) provide an excellent summary of the marginal cost controversy debate and the lasting relevance of Coase’s argument today.) While acknowledging the efficiencies inherent in marginal cost pricing, Coase argued that imposing lump-sum taxes to pay for firms’ fixed costs would not actually result in the most efficient outcome. Coase distilled the problem down to three essential parts: 1) The divergence between marginal cost and average cost, with marginal cost lower than average cost; 2) The allocation of common costs across consumers; 3) That many fixed costs are pre-payments on long-term contracts for inputs that could be considered variable costs. While the divergence between marginal and average cost is the predominant analytical issue, the other two are tricky. When there is a common fixed cost that must be shared across consumers, economic theory does not suggest a single, clear, definitive method of doing so. In electricity, for example, much of the capital in the distribution system creates a shared network that different consumers use to different degrees (and at different times of day). Kiesling I 47 How should the costs be apportioned among these different consumers, particularly at the time Coase was writing, when digital technologies did not exist to enable precise measurement of use of the distribution grid? This question of the apportioning of common costs remains relevant in regulated electric utility rate design. CoaseVsHotelling: [Coase] argued that while price would equal marginal cost, resource misallocation would still arise because neither producers nor consumers would take fixed costs into account in making production and consumption decisions. Taxation/fixed costs: In other words, if fixed costs were paid for through taxes or subsidies, neither producers nor consumers would have any incentive to consider the opportunity cost of those resources. Price/opportunity cost: Coase also argued that in the absence of a market price that reflected opportunity costs, there would be no institutional framework, no market process, for learning whether or not consumers were willing to pay the full cost of the output they consumed; this observation overlaps with the challenge of allocating common costs across consumers. Common good: Finally, Coase observed that in Hotelling’s system the redistribution of wealth from people who used only a little of the product in question to those who used a lot of it would be almost unavoidable. Redistribution: Wealth redistribution would also arise from the mismatch between consumers and taxpayers - not all consumers of the firm’s output would necessarily be taxpayers, and vice versa. Incentives/CoaseVsHotelling: Rather than accepting Hotelling’s static analysis of an already-existing decreasing-cost firm, Coase performed a dynamic analysis of the broader incentives of Hotelling’s proposal and the realistic institutional framework that would be required to implement it. How would the government determine consumer demand to learn consumer preferences, to make sure that the right amount and type of fixed costs were incurred? >Preferences, >Government policy. In his emphasis on government ability to acquire knowledge, government performance, and the assumption of government as neutral public servants, Coase makes points that presage the later developments of public choice economics in the 1950s and 1960s. Kiesling I 48 Solution/Coase: Coase made an alternative proposal to Hotelling’s: multi-part pricing. While he did not provide specifics in his 1946 article, his idea was to have the price include a component that reflected the marginal cost and a component that allocated the fixed cost, subject to the constraint that the firm does not earn losses; this example is called a two-part tariff. Such pricing incorporates all costs into the prices to which producers and consumers respond, and does not involve either the funding problems or institutional incentive problems that Coase identified with the tax/subsidy proposal. Multi-part pricing does not avoid the problem of allocating common costs across consumers, and such allocation will also be the province of estimates and be prone to bureaucratic manipulation, but it may be the best we can do given realistic assumptions about our constraints and the limitations of our knowledge. Today: Coase’s analytical framework for decreasing-cost industries persists to this day in the form of regulated rate setting in the electricity and natural gas distribution industries. If you look at your electric bill you will see a variable “energy charge,” reflecting marginal cost, and a “wires charge” or “carrying charge,” that allocates a share of the fixed costs of constructing, maintaining, and operating the distribution network. At least in theory, regulated rate setting is grounded in Coase’s logic. >Efficiency/Coase. 1. Hotelling, H. (1938). The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates. Econometrica, 6 (3), 242–269. https://doi.org/10.2307/1907054 2. Coase, Ronald H. (1946). The Marginal Cost Controversy. Economica 13, 51: 169-182. 3. Frischmann, Brett M., and Christiaan Hogendorn (2015). Retrospectives: The Marginal Cost Controversy. Journal of Economic Perspectives 29, 1: 193-206._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Coase, Ronald Kiesling I L. Lynne Kiesling The Essential Ronald Coase Vancouver: Fraser Institute. 2021 |
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> Counter arguments against Coase
> Counter arguments in relation to Decreasing-Cost Industries
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