Social-Optimal Pricing in Mainstream Economics: Marginal Cost Pricing (MCP) and Second Best Pricing (SB). A Critical Review

Abstract

MCP is a normative theory derived from the modern-neoclassical model of the ‘General Equilibrium of perfectly competitive markets’ (GE model), and based on its concept of socially-optimal price for a given product or service, in a free markets economy. In such a theoretical scenario, all prices are equal to the respective marginal cost (allocative efficiency); which, in turn, is equal to the ordinary unit (average) cost of the good – since all firms are supposed to operate with full productive efficiency, as perfect cost-minimisers. As a theoretical consequence, the GE model entails price=marginal cost=average cost for any firm producing a given good; therefore, firms sell at cost price, without profit. In the standard model, this is the meaning and implications of a socially-optimal price.

MCP is advocated, in economic policy, for price regulation regarding specific goods ‒ usually services. And, more precisely, as the theoretical economic base for ‘market design’ – as, f.e., in the case of the electricity sector in most countries. In this paper, the theoretical bases and implications of MCP and its historical derivative, the Second Best pricing (SB), are presented and reviewed.

Keywords: Firms' Unit Costs regarding scale of production, Marginalism, Market design, Prices Regulaton, Normative economics

JEL Classification: D21, D22, K23, L51, D47, D60