Calculating Developer Charges for Urban Infrastructure: A Feasible Method for Applying Marginal Cost Pricing

Abstract

In common with other realms of economic endeavor, marginal cost pricing is socially optimal in guiding both the use of existing local public services as well as investment in these services (Baumol and Bradford [2]). But urban infrastructure, such as water supply, sewerage and drainage, has a number of idiosyncratic features, like lumpiness, uncertainty over demand, and inherited systems, which make the determination of marginal cost in the real world extremely difficult. Turvey [15] argued that in these circumstances marginal costs center on "central system costs" that can be thought of as the "headworks" and major capital works of an infrastructure service network that are characterized by longevity, lumpiness and excess capacity.Each infrastructure service provider is envisaged as having a schedule of investment plans into the future that optimizes production and investment timing. Put differently, the schedule minimizes the expected present worth of all avoidable costs and no change in the way planned output is produced will lower the present worth of these future costs. If we postulate that demand for the service unexpectedly, but permanently, rises (or falls) by a given amount, then output must also adjust to accommodate this permanent increment. This means that planned future investments will have to be rescheduled. Perhaps a rescheduling of the whole program will be necessary, but at a minimum, the timing of some future expansions of capacity will have to be brought forward. This implies that there will be a new present worth of the stream of future costs that now takes the permanent increment into account. Turvey [13] defined marginal cost as the difference between these two cost streams.If we accept the convention of excluding expected running costs from developer charges, then we can define an ideal developer charge for headworks and major works of some infrastructural service by applying the Turvey [15] concept of marginal cost. An ideal charge would equal the MCC of the permanent output increment required by the development, measured as follows: The present worth of the least-cost investment expenditure stream with the permanent output increment that a development will occasion less the present worth of the least-cost investment expenditure stream without the increment due to development.