Question

Thomas Kinnaman, an economist at Bucknell University, analyzed the pricing of garbage collection: Setting the appropriate fee for garbage collection can be tricky when there are both fixed and marginal costs of garbage collection.... A curbside price set equal to the average total cost of collection would have high garbage generators partially subsidizing the fixed costs of low garbage generators. For example, if the time that a truck idles outside a one-can household and a two-can household is the same, and the fees are set to cover the total cost of garbage collection, then the two-can household paying twice that of the one- can household has subsidized a portion of the collection costs of the one-can household.

Short answer

The setting of garbage collection fees can be complex due to the presence of both fixed and marginal costs. If a fee is set based on average total cost, this could potentially lead to households with greater garbage generation subsidizing the fixed costs of households with lesser garbage. A possible solution to this issue could be implementing a two-part tariff that separates the fixed and marginal costs.

Step-by-step solution

Understand Key Terms and Concepts

This exercise uses a few key economic terms and concepts. Fixed Costs are costs that do not change with the level of output - in this case, the idle time for the truck remains the same no matter if a house disposes of one or two cans of garbage. Marginal Costs are incremental costs incurred when an extra unit of output is produced - here, the cost associated with collecting and disposing of each additional garbage can.

Examine the Issue with Average Cost Pricing

Let's analyze the implications of setting the fee based on the average total cost. Since the fixed costs (idle time of the truck) are not influenced by the number of cans, if we distribute these costs evenly among the households, irrespective of their garbage generation (one can or two cans), then households generating two cans would pay twice as much.

Analyze the Subsidy Issue

Next, since a household with two cans is charged twice, even though the fixed cost (truck idle time) is the same for both types of households, this can be interpreted as the household with two cans subsidizing the fixed cost of collection for the household with one can.

Consider An Alternative Pricing Strategy

To tackle this issue, a better approach might be to introduce a two-part tariff where there would be a fixed fee (for example, for the idling time) and then an additional fee for each garbage can. This would ensure that the price reflects both the fixed and marginal costs more accurately and there would be no inadvertent subsidy.

Key concepts

Fixed Costs

Understanding the concept of fixed costs is crucial in the economics of garbage collection pricing. Fixed costs are those expenses that do not fluctuate with the level of output. This could include the cost of garbage trucks, employee salaries, and other overheads. For instance, the time a garbage truck spends idling outside a house remains constant regardless of whether the household has one trash can or multiple cans. To put it simply, these are like the baseline expenses that the service must cover to operate, and they don't change no matter how much trash is collected.

When setting prices for garbage collection, ensuring that fixed costs are covered is essential, but how these costs are allocated among consumers can influence fairness and efficiency within the pricing structure.

Marginal Costs

Switching focus to marginal costs, these represent the costs incurred for providing incremental units of service or product. In the context of garbage collection, the marginal cost would relate to the expenses involved in collecting and disposing of each additional can of garbage. This includes things like fuel for additional distance traveled to pick up the extra can, extra wear and tear on equipment, and time spent by employees handling the extra trash.

From the perspective of a waste management company or municipality, knowing the marginal cost is key for creating pricing strategies that are fair. If pricing does not take marginal costs into account, large waste generators could end up paying proportionately less than they should, while smaller waste generators pay more, which does not reflect the true cost of service.

Average Cost Pricing

Average cost pricing is an approach where the fee charged is based on the average total cost of providing services, including both fixed and variable costs. This method may seem straightforward, but it has implications for equity among consumers. If a flat rate is charged that averages out the combined costs, customers with lesser usage effectively subsidize those with more substantial usage.

For a garbage collection service, if the fee is set to cover the total average cost, a household producing less waste pays the same for the fixed cost component as a household that produces more waste. This leads to a subsidy situation where the low waste generators are paying a proportionally higher fee than high waste generators as they contribute to the fixed cost recovery that benefits all users.

Two-Part Tariff

A two-part tariff offers a solution to the potential inequity in average cost pricing. It is a pricing method that includes a fixed fee plus an additional variable charge that relates directly to usage. In the case of garbage collection, this could mean a set base fee for the service that represents fixed costs like the idling time of the truck, alongside a per-can fee that covers the marginal costs of collection for each can.

This pricing structure ensures that customers pay for the fixed service availability but also proportionately for their level of usage. It is a balanced system that can meet the costs of providing a service while maintaining fairness among consumers with different levels of waste.

Economic Subsidy

An economic subsidy occurs when a segment of users pays less than their fair share of the costs, often due to a pricing strategy that doesn't align costs with usage. In a garbage collection system, if heavy generators of waste are not paying an amount that accurately reflects their additional costs, then they are being inadvertently subsidized by the lighter waste producers.

This issue has broader implications on waste behavior and environmental impact, as people might not be incentivized to reduce waste if they're not facing the full cost of disposal. To address this, precise pricing strategies that couple services with their true costs can be employed to not only ensure financial sustainability but also to encourage waste minimization through economic signals.