The Welfare Economics of Universal Service Standards and Service Quality

Abstract

This paper proposes a welfare economics approach to the analysis of the provision of universal service and quality of service standards. In the absence of quality considerations such an analysis demonstrates that total welfare, expressed as the sum of producer profits and consumer surplus, is maximised when marginal cost is equal to marginal price. In industries, which have low marginal costs, such as postal services, since such a solution would lead to losses for the incumbent operator, a “second best” solution is chosen in which welfare is optimised subject to the constraint that the producer breaks even. For multi-product producers this leads to the well-known pricing rule that the mark-up of prices above marginal cost should exceed the marginal cost of supply in inverse proportion to the price elasticity of the products.