PRODUCTION EFFICIENCY AND OPTIMAL PRICING IN INTERMEDIATE-GOOD REGULATED INDUSTRIES

This paper reconsiders the relationship that exists between the production efficiency result of Diamond and Mirrlees and the Ramsey Rule. Specifically, the paper considers a general equilibrium hierarchical structure of production. One industry sells at least some of its output to another regulated industry. A single regulatory agency must balance the budgets of all regulated industries in the aggregate so as to maximize the utility of a representative individual. The Ramsey Rule always holds. Pricing rules, however, are far more complex. The optimum may have some negative price-cost margins and may not involve production efficiency. © 1990.