1 Beyond Avoidable Costs Marcel Boyer, Université de Montréal et CIRANO Michel Moreaux, Université de Toulouse et CIRANO Michel Truchon, Université Laval et CIRANO Competition Bureau, Ottawa March 8, 2002.

2 I. The economic foundations of the notion of avoidable costs. II. The practical applicability III. The economics of cost-sharing IV. Properties of the main methods V. Competition policy implications

3 The standard case Increasing marginal cost Pure competition equilibrium and efficiency rule: p=mc p<mc to develop and exercise market power Competition law and policy to control the development and exercise of market power

4 The non-standard cases Fixed cost and constant marginal cost Economies of scale and scope (decreasing marginal cost) Natural monopolies Network economies

5 The non-standard solutions First-best: p=mc and a subsidy

6 The non-standard solutions First-best: p=mc and a subsidy Budget constraint (no subsidy): second-best Ramsey-Boiteux pricing based on the inverse elasticity rule

7 The non-standard solutions First-best: p=mc and a subsidy Budget constraint (no subsidy): second-best Ramsey-Boiteux pricing based on the inverse elasticity rule X-inefficiencies and information asymmetries

8 The non-standard solutions First-best: p=mc and a subsidy Budget constraint (no subsidy): second-best Ramsey-Boiteux pricing based on the inverse elasticity rule X-inefficiencies and information asymmetries Competition-based policy to control anti-competitive behavior

9 Competition-based control: The Competition law To solve the standard cases To solve the non-standard cases

10 Competition-based control: The Competition law To solve the standard cases To solve the non-standard cases In non-standard cases, the competition-based control may appear to implement a non-efficient solution

11 Competition-based control: The Competition law To solve the standard cases To solve the non-standard cases In non-standard cases, the competition-based control may appear to implement a non-efficient solution The cost-sharing approach –Cooperative game between stakeholders –All costs are shared –“Second-best” or “Third-best” approach

12 Beyond avoidable costs: the cost-sharing approach Customers as stakeholders in recovering costs (classes and coalitions) Think in terms of properties (axioms) Develop a method to share costs From prices to cost-sharing payments

13 Some non-standard examples Underground infrastructures Pacific Bell vs. Cable operators CCT: public-private competition Airline competition Shared computing facilities

14 Shapley-Shubik (SS) cost-sharing rule Generalizes the notion of avoidable costs and incremental costs In non-standard framework, the incremental cost of a good or facility depends on the rank at which the good of facility is introduced But the sequence (rank) is arbitrary SS takes the average incremental costs obtained over all possible rankings

15 Properties of the SS cost-sharing rule (1) Symmetry or Anonymity * Invariance of the cost shares to the elimination of dummies * Invariance of the cost shares to the decomposition of total cost into specific and joint costs Demand monotonicity Cross demand monotonicity The Core property or the stand alone test Additivity and Ordinality *

16 Properties of the SS cost-sharing rule (2) It is the only cost-sharing rule that satisfies the * properties: –Symmetry or Anonymity –Dummy –Additivity and Ordinality It is a costless surrogate for the allocation that would be obtained through bargaining

17 Serial cost-sharing rule (1) Generalizes the notion of price Equal treatment of equals The Serial Principle: The benefit and the cost generated by a large consumption/use should accrue to that customer (no advantage and no burden for the smaller users)

18 Serial cost-sharing rule (2) Stakeholders’ demands are ordered from the smallest to the largest (in quantity or in cost) All customers of the smallest demand level (good, segment/facility, equivalent cost) share its cost equally All customers of the second smallest demand level (good, segment/facility, equivalent cost) share its incremental cost equally And so on … till the largest demand is covered.

19 Properties of the Serial rule It is the only cost-sharing rule that satisfies –the “Equal treatment of equals” –and the “Serial Principle”: The benefit and the cost generated by larger customers accrue to those customers (no advantage and no burden for the smaller users)

20 The applicability of cost-sharing rules Data Computer programs

21 Implications for Competition Policy Pacific Bell vs. Cable operators CCT: public-private competition Airline competition Shared computing facilities: competition between providers (outsourcing) The future: more and more cases ?