A firm with market power in one market may charge a high price for non-competitive products and use the proceeds to subsidize low prices for competitive products.
The remedies for cross-subsidization are preventative in nature:
Figure 1: Remedies for Cross Subsidization
Price Floor
For a firm that at least breaks even across all of its products, any single product receives a subsidy if the revenue it generates fails to recover its total service long run incremental cost (TSLRIC). Thus, the effective price floor in a test of whether a product receives a subsidy is:
TSLRIC of the service / number of units produced
For a multiproduct firm, the rule for preventing cross-subsidization requires that, for a firm that at least breaks even, every product must satisfy this price floor test.
Accounting Separation
The objective of accounting separation in this context is to separate the costs of the firm’s competitive and non-competitive products. This can be achieved through price regulation (either direct regulation, or a “price cap”). Such regulation can prevent cross-subsidization by allocating competitive and non-competitive products to separate “baskets”, with separate controls or rules for the each basket.
RELATED INFORMATION
Cross-Subsidization