A cross subsidy is a market transfer induced by discriminatory pricing practices within the scope of the same enterprise or agency. Typically it exists when a government-owned enterprise, such as a public utility, uses revenues collected in one market segment to reduce prices charged for goods in another. Some definitions also include similar practices carried out by private firms, as when an integrated airline allocates part of the costs of its activities in a highly contested geographical or product market (e.g., the transport of freight) to another market (e.g., passenger transport) that is better able to bear those costs. For example, some airports cross-subsidize costs associated with serving airline passengers through sales on duty-free goods.
One of the most common forms of cross subsidy is that between consumers of electricity and consumers of irrigation water. Managers of large hydro-electric works that store and channel water for irrigation as well as generate electricity have to decide how to allocate the costs that are common to both activities (notably, the construction and maintenance of the dam and reservoir) between farmers and buyers of electricity. Government regulations will often dictate that an even smaller portion of the costs be allocated to irrigation than would be efficient according to established pricing principles.
Not all instances of price discrimination are evidence of cross subsidies, however. For example, differences in the volume (if there are economies of scale in delivery) and interruptibility of service, among other factors, can lead to different price schedules for different classes of customers.
