Review of Industrial Organization
12: 485–499, 1997.
1997 U.S. Government. Printed in the Netherlands.
Fuly Distributed Cost Pricing, Ramsey Pricing, and
Shapley Value Pricing: A Simulated Welfare
Analysis for the Telephone Exchange
D. MARK KENNET
U.S. Bureau of Labor Statistics, Washington, DC 20212, U.S.A.
DAVID J. GABEL
Queens College, Flushing, NY 11367, U.S.A.
Abstract. Economic theory has long been concerned with determining the optimal pricing scheme for
a multiproduct monopoly, but it has been quite difﬁcult to make use of developments in practice. Using
LECOM, the Local Exchange Cost Optimization Model, over three stylized city maps, and assuming
price elasticity values taken from the literature for four standard outputs of the local exchange, we
demonstrate how fully distributed cost prices, Ramsey-optimal prices, Shapley prices, and standalone
prices can be computed for a variety of baseline output levels. Analysis of consumer surplus changes
relative to the marginal cost baseline shows that while Ramsey pricing maximizes social welfare over
the set of schemes considered, only the Shapley approach results in subsidy-free prices.
Economic theory has long been concerned with determining the optimal pricing
scheme for a multiproduct monopoly. A large second best pricing literature has
developed that provides pricing formulas for policy makers that will maximize
society’s welfare under various conditions.
Despite the theoretical appeal of Ram-
sey pricing, regulatory commissions have been reluctant to adopt the method. In a
review of the record, Huettner (1982) stated that Ramsey “principles are yet unused
by virtually every regulatory agency in the U.S.
In a more recent survey of the contributions made by economists to private
industry and government agencies, Faulhaber and Baumol (1988) pointed out that
until recently, Ramsey pricing was given little attention by regulators. They were
pleased toreport thatin a “landmark decision” ofthe Interstate CommerceCommis-
sion, the agency considered adopting Ramsey pricing, and even explicitly accepted
We gratefully acknowledge funding for development of the software used in this project from the
National Regulatory Research Institute while the ﬁrst author was on the faculty of Tulane University.
We owe thanks for research assistance to Alyce Grillet and for helpful comments to David Malueg,
Mark Loewenstein, and two anonymous referees. Opinions expressed in this paper are those of the
authors only, and do not represent the opinions of the Bureau of Labor Statistics or of other employees
of the Bureau of Labor Statistics. Remaining errors are our own responsibility.
See Mitchell and Vogelsang (1991) for a recent review of the literature.