Ramsey Pricing and Environmental Regulation

The optimal pricing rule for public enterprises maximizing welfare under a profit constraint is well known. The paper extends the analysis to the case of production externalities and considers price regulation under various forms of environmental regulation which is assumed to be performed by a separate environmental agency. The modified Ramsey prices depend on the institutional setting. If the enterprise is liable for the damages it causes the externality is fully internalized. If an environmental tax is imposed the way its revenue is spent turns out to be crucial. The connection to Pigouvian taxes under imperfect competition is illuminated.