cross+subsidies

Katie Crist

Cross-Subsidy
This is a pricing strategy in which profits from the sale of one product are used to subsidize sales of a related product (Baye, 419). When a firm has related products it may chose to charge a price that is at or below cost for one product and sell the other at a price above cost. Sometimes the firm may chose to take a loss on one product and supplement the loss by charging a higher price for other products. It can also be said that a service provides a cross-subsidy to other services in the same network if the charge for that service exceeds the standalone cost of providing the service.

Cross-subsidizing in some cases is used to make products and services more affordable to people. For example, cities may choose to use the revenue from one mode of transportation to cross-subsidize another mode. Subway revenues could be used to cross-subsidize bus transportation. Cities use this strategy to reduce the traffic congestion. So both the city and people benefit. http://www.vtpi.org/tdm/tdm70.htm

Real World Practices
The example in the book deals with Adobe and its products. Adobe offers Acrobat Reader for "free" to anyone who is willing to download the product from their website. This software is used to view portable document format, pdf, files. On the other hand, if a person wishes to create or manipulate pdf files, Adobe Acrobat must be purchased (Baye, 419). The current price of Adobe Acrobat 8 Professional is $449.00 for the whole package and $159.00 to upgrade. http://acrobat.landingpage1.com/lp1.html?sdid=MRSV Adobe engages in this practice because it is profitable. By offering the Acrobat Reader for free, the users might be enticed to purchase the full software.

Cross-subsidies are often times seen in the electrical market. Often times electricity charges are based soley on a per kilowatt hour (kWh) basis, ignoring the fact that much of the cost associated with electricity service is fixed. From this basis, cross subsidies have been implemented to achieve various social objectives such as affordable rates for the economically disadvantaged or extension of service to perviously unserved areas. In the case of electricity rates, lump sum transfers throught the fixed charge portion of the mulitpart tariff are used to implement cross subsidies across customer classes without distorting consumption decisions and are efficiency enhancing. http://bear.cba.ufl.edu/centers/purc/primary/documents/SA2005-cross-subsidy-paper.pdf

Cross subsidizing can be found in the housing market. Rydon Construction is currently working on a project that involves selling 97 private apartments. The funds will be used to subsidize 24 new flats available for elderly rent, the refurbishment of 38 elderly owned flats, a playground available for public use, a doctor's surgery, and a parking lot. http://www.rydon.co.uk/rydongroup/assets/html/construction_cross-subsidy_pdfs/Cable%20Street.pdf

Questions
1. In a cross-subsidy if one product is sold at or below cost, the other must be sold: a. at cost b. below cost c. above cost d. none of the above

2. Products should be _______ for a cross-subsidy to work. a. interdependent b. divisional c. unique d. dependent

3. Which is NOT an example of a cross subsidy? a. selling apartments to subsidize elderly flats b. using bus revenues to subsidize a subway c. subsidizing Acrobat Reader with profits made on Adobe Acrobat software d. government subsidizing a library with a grant

4. True or False: A firm may enhance profits by cross-subsidizing.

5. True or False: Cross-subsidy works for every firm.

1. c 2. a 3.d 4. true 5. false