Ramsey Pricing Revisited: Natural Monopoly Regulation With Evaders

We consider a model featuring a single‐product natural monopoly, which faces evaders, that is, individuals who may not pay the price. By exerting costly effort, the firm can deter evasion. To maximize total surplus, a regulator sets the price, the level of deterrence effort, and socially costly transfers to ensure the monopoly's participation. We obtain a modified Ramsey formula, which clearly shows that the mere existence of evaders dampens the use of the price as a means to finance the firm's deficit. The regulated price is always below the monopoly price and, under sufficient conditions, also below marginal cost. We find conditions under which the regulated price decreases if society departs from fully crediting evaders' utilities to welfare. Then, we generalize the model to incorporate moral hazard.