Cost Allocation and Demand Revelation in Public Enterprises

Young, H.P. (1980). Cost Allocation and Demand Revelation in Public Enterprises. IIASA Working Paper. IIASA, Laxenburg, Austria: WP-80-130

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Abstract

A classic problem in both the public economics and game theory literature is how to allocate the joint costs of a public enterprise equitably among the customers. Traditional normative solutions, like Ramsey pricing or the Shapley value, have the distinct disadvantage of requiring full information about demand, which in practice may not be known. This paper describes a simple noncooperative bidding mechanism that discovers the efficient set to serve and simultaneously allocates costs. Consumers bid to be served and the game regulator offers to serve that' coalition that maximizes net surplus. It is shown that a Nash equilibrium -- indeed a strong Nash equilibrium -- for this noncooperative game always exists, no matter what the cost function, and the resulting set of consumers served is economically efficient. The resulting allocations constitute a normative solution concept for cooperative games that is apparently new and generalizes the core in a natural way. The principal application is to determine prices and output levels for a regulated public enterprise with incomplete information about demand.

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