Question

What is the usefulness of no profit no loss principle today?

Answer 1

Answer:

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Economists like Lewis, Coase, Durbin, Henderson, and little advocate no-profit no-loss policy or the principle of break-even for PSEs. Their contention is that PSEs are meant to serve public interest and not to make profits.

According to Lewis, the price policy of PSEs should be such that they should make neither a loss nor a profit after meeting all capital charges. He further states that what the economists principle supports is not the MC pricing but a system of charging what the traffic will bear’ so that consumers contribute to fixed costs according to their capacity to pay.

Lewis supports this policy on the ground that it prevents over-expansion and under-expansion of PSEs and avoids inflationary and deflationary tendencies. Other economists opine that PSEs should pay their way taking one year with another. They should fix such a price for their products or services so as to break-even over a period of years, making neither losses nor profits.

The no-profit no-loss policy means that the prices of PSE products or services should cover total costs. Total costs include all types of expenses incurred by a PSE in producing a product. They are short-period and long-period fixed and variable costs of production, current and replacement costs, depreciation charges, interest on capital employed, and advertisement, selling and distribution expenses.

These costs may be covered by making the price equal to the average total costs of production or by following two-part or multipart policy.

The full cost or average cost pricing policy is advocated on the following grounds. Full-cost prices of a PSE are based on its average total costs of production which can be easily estimated from an enterprise’s accounting records. It is better to fix full-cost price for merit goods, such as highways, public transport, public education, public libraries, museums, recreation parks, etc.

For all such services, people should be charged a price instead of providing them free or at concessional rates. Full-cost prices lead to neither profits which compensate for losses so that there is neither loss nor profit.

Further, full-cost prices cover average total costs of production and also yield a fair return on the PSE’s capital investment. Full-cost pricing under diminishing returns is illustrated in where the AC curve cuts the AR curve at point R which determines OQ output and QR price. This price enables the enterprise to break­even by covering its average total costs of production. It earns normal profit.

If the PSE has a monopoly in supplying

public utility service, it may have increasing economies of scale over a

wide range of output, showing increasing returns or diminishing costs.

This case is illustrated where the AC curve cuts the AR curve at point R under

the AC pricing rule and provides OQ

services at QR price