Second best pricing of publicly produced inputs: The case of downstream imperfect competition

Efficient second best pricing is examined for a public enterprise facing two distortions: a profit constraint and imperfect competition among some customer industries. We suggest a measure of downstream industry distortion for the purpose of efficient pricing. The pricing rule contains two opposing elements: the shadow value of public profit and this measure of the downstream distortion, whose sum determines whether the efficient second best input price is above or below marginal cost. Efficient pricing normally implies relative subsidization of imperfectly competitive downstream firms.