5 - Normative Piecemeal Theory

Abstract

This chapter presents the normative piecemeal theory. A theory of piecemeal policy yields sufficient conditions for welfare improvements, as opposed to an optimum theory that yields necessary conditions that are fulfilled at the optimum. The optimum Ramsey pricing policy states that it is a necessary condition for an optimum that price-cost margins are fixed according to an inverse-elasticity rule. A piecemeal Ramsey policy states that, given some public prices, near the optimum but still nonoptimal, an increase of the price-cost margin of a price-inelastic good is a sufficient condition for a welfare improvement. However, this property need not always hold for all welfare-increasing price changes along a path from nonoptimal prices to optimal prices. If the present situation is far from the welfare optimum, there are so many different ways to increase welfare that clear-cut rules, comparable to optimum rules, usually will not be obtainable. Therefore, the general results of a theory of piecemeal policy are disappointing. However, this does not mean that a theory of piecemeal policy is unimportant. After specifying all relevant functions, it may well serve as the basis for the board's decisions on how to proceed step by step.