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Cross-Subsidization

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Cross-Subsidization 

Cross subsidization is where one group pays a relatively high price thereby allowing another group to pay a relatively low price.

Moulin, Hervé and Yves Sprumont (2006). “Responsibility and Cross Subsidization in Cost Sharing.” Games and Behaviour (55), pp. 152-188. 

 

Classical theories of fair pricing rest upon the assumption that prices should be determined by supply and demand (with no cross-subsidization). Thus, investments made that benefit only the agent should be separable from other transactions, with the full cost borne by the agent. This notion of ‘separability’ is important because it implies ensuring that the right incentives are in place – that people pay for what benefits them. Of course, ensuring this separation of costs becomes more difficult with complex pricing systems, or in cases where benefits are shared. Cross-subsidization was later deemed acceptable only to correct cost asymmetries.

 

However, while recent economic cost sharing models generally suggest that it is reasonable to hold agents/consumers responsible for the share of their demand (use more, pay more), opinions differ as to whether there should be cost sharing to address asymmetries in price (it costs more to deliver the same amount of the same service to one agent than to another). On the one hand, there is an economic rationale for using cross-subsidizing methods. For example, farming is a productive industry but the farmer can’t work from town and thus shouldn’t be penalized. On the other, cross-subsidization encompasses fundamental egalitarian principles that justify providing more costly para-transit at the same price as other forms of public transit.

 

There are many other examples of cross-subsidization. The post office charges the same rate to ship a letter from Toronto as from Nunavut – thus the Toronto user subsidizes her Nunavut counterpart. Similarly, the basic phone bill is the same despite the higher cost of connecting isolated communities.

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© University of Toronto 2008
School of Public Policy and Governance