Trisha Shetty (Editor)

Cross subsidization

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Cross subsidization is the practice of charging higher prices to one group of consumers to subsidize lower prices for another group. State trading enterprises with monopoly control over marketing agricultural exports are sometimes alleged to cross subsidize, but lack of transparency in their operations makes it difficult, if not impossible, to determine if that is the case.

Suppose Alex goes to dinner with two of his friends, Leo and Lin. Alex's meal costs $25, Lin's meal costs $20, and Leo's meal costs $15. The total bill is then $60, and everyone decides to split the bill evenly, for $20 each. Alex's meal is undercosted. Leo cross-subsidizes Alex for $5. Lin is neither cross-subsidized nor cross-subsidizes anyone else.

An example of cross subsidization may occur in the banking industry. Fees associated with maintaining a low account balance (below $1,000 for example) are charged to these customers to maintain their profitability.

In many countries, telecommunications (including broadband accesses), postal services, electricity tariffs, and collective traffic among others are cross subsidized. In some cases, there is a universal price ceiling for the services, leading to cross subsidies benefiting the areas for which the costs of provision are high.

Criticism

According to the Finnish member of parliament, political economics author and statistician Osmo Soininvaara, cross subsidization causes welfare losses. Even if there were reasons for subsidizing bus or train ticket prices on sparsely populated areas, it is better to collect the required money by general taxes instead of raising prices on profitable areas that better suit for collective traffic. He also notes that in sparsely populated areas, cars are often more ecologically friendly than buses.

Some economists argue that cross subsidization in state owned enterprises increases the likelihood of anticompetitive practices such as predatory pricing. They argue that regulators, such as U.S. postal regulators, should monitor a state monopoly's cost allocation to ensure that revenue generated in the monopolized market is not used to lessen competition in competitive markets.

References

Cross subsidization Wikipedia


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