Pricing of public utilities and government policy

Pricing of public utilities and government policy

Priority to public

There are a number of principles which govern the pricing of public utility services. There are public utilities like education, sewage, roads, etc. which may be supplied free to the public and their costs should be covered through general taxation. Dalton calls it the general taxation principle. Such services are pure public goods whose benefits cannot be priced because they are indivisible.

It is not possible to identify the individual beneficiaries and charge them for the services. In some cases, the beneficiaries may be identified but they cannot be charged for their use. For instance, the users of a bridge (flyover) over the railway line can be identified, but it may be inconvenient to the taxing authority to collect the road tax and for the road users to pay the tax due for the time involved.

The best course is to finance the flyover out of general taxation. J.F. Due has mentioned the following four rules where public services should be provided free and their costs covered from general taxation.

Firstly, in the case of such services where little waste will occur if they are provided free. Second, where charging a price will restrict the use of the service. Third, where the cost of collecting taxes is high.  Fourth, where the pattern of distribution of tax burden on services is inequitable.

These rules are applicable to a few essential public services like education, sewage, roads, etc. But in the case of services other than those included under “pure public goods,” free services might lead to wastage of resources.

The general principle for pricing such public services is to recover costs without distorting the allocation of resources. This is done by making selling price equal to short-run marginal costs while keeping productive capacity constant. But water and power systems periodically require large investments. In such cases, average costs fall as production is increased and the actual price charged is below the average cost.

 

Marginal Cost Pricing Rule

 

One of the aims of PSEs is to be economically efficient or to maximise social welfare. If a PSE has a monopoly in the production of a good or service, it will not be economically efficient because it produces where MC=MR. However, for more efficient resource allocation, it is essential to find out whether the PSE is operating under decreasing or increasing returns.

If price equals MC under decreasing returns, the PSE will earn profits and if it is operating under increasing returns, the PSE will incur losses. Thus the application of the marginal cost pricing rule to PSEs has implications for the financial position of the enterprise.

No-Profit No-Loss Policy

Economists like Lewis, Coase, Durbin, Henderson, and little advocate no-profit no-loss policy or the principle of break-even for PSEs. Their contention is that PSEs are meant to serve public interest and not to make profits.

According to Lewis, the price policy of PSEs should be such that they should make neither a loss nor a profit after meeting all capital charges. He further states that what the economists principle supports is not the MC pricing but a system of charging what the traffic will bear’ so that consumers contribute to fixed costs according to their capacity to pay.

Lewis supports this policy on the ground that it prevents over-expansion and under-expansion of PSEs and avoids inflationary and deflationary tendencies. Other economists opine that PSEs should pay their way taking one year with another. They should fix such a price for their products or services so as to break-even over a period of years, making neither losses nor profits.

The no-profit no-loss policy means that the prices of PSE products or services should cover total costs. Total costs include all types of expenses incurred by a PSE in producing a product. They are short-period and long-period fixed and variable costs of production, current and replacement costs, depreciation charges, interest on capital employed, and advertisement, selling and distribution expenses.

Profit-Price Policy

In developing countries like India where PSEs are required to play a dominant role in economic development, PSEs follow the profit-price policy. The profit-price policy was first put forward in India by Dr. V.K.R.V. Rao in June, 1959. In a Note to the AICC Seminar on Planning held at Ooty, he categorically rejected the theory of no-profit no-loss for PSEs and argued for the adoption of profit-price policy.

Such a policy would make the state utilise its own resources rather than taxing its citizens. According to him, PSEs must be carried on a profit making basis not only in the sense that the public enterprises must yield an economic price but also get for the community sufficient resources for financing a part of investment and maintenance expenditure of the government. This involves a profit-price policy in regard to PSEs.

The theory of no-profit no-loss in PSEs is particularly inconsistent with a socialist economy and if followed in a mixed economy like India, it will hamper its development. In support of his view, Prof. Rao quoted the example of the erstwhile USSR. In the USSR, PSEs made a double contribution to development finance: reinvestment of profits for their own expansion and contribution to the state budget.

 

 

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