Theoretical Health Economics by Keiding Hans

Author:Keiding, Hans
Language: eng
Format: epub
ISBN: 9789813227835
Publisher: World Scientific Publishing Company
Published: 2018-08-12T16:00:00+00:00

5.3Ramsey pricing

When prices are set so as to cover cost, but with the objective of maximizing welfare retained under this constraint, the problem to be solved is to determine how much of the aggregate cost should be recovered through the price of each good or service. Intuitively one might be tempted to choose a proportional rule, but this rule neglects the underlying details of consumer satisfaction as weighted against cost, indicating that demand elasticities might play a role, as indeed they do.

Formally, we face the task of choosing prices p1, . . . , pm of the m commodities marketed by the firm or the healthcare organization, so that consumer welfare is maximized under a profit constraint (here taken to be zero profits, but the argument works with any other predetermined level of profits). It turns out to be convenient to work with the consumer’s expenditure function, e(p, r) which indicates the smallest outlay for the consumer if she wants to attain the utility level r by purchasing commodities at the prices p = (p1, . . . , pm). Now the problem of finding the welfare maximizing prices under the profit constraint can be written as

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