Mathematical Social Sciences 53 (2007) 140 – 149

www.elsevier.com/locate/econbase

A characterization of the pseudo-average cost method

C. Larrea, J.C. Santos a,⁎
a
Departamento de Economía Aplicada IV, University of the Basque Country, Lehendakari Agirre,
83, 48015 Bilbao, Spain
Received 2 June 2006; received in revised form 5 October 2006; accepted 19 October 2006
Available online 30 November 2006

Abstract

We study the pseudo-average cost method in discrete and continuum cost allocation problems. This
solution was introduced, in the discrete case, by Moulin (Moulin, H., 1995. On additive methods to share
joint costs. The Japanese Economic Review 46, 303-332). In the continuous case, this solution has been
introduced, asymptotically, by Larrea and Santos (Larrea, C., Santos, J.C., 2006. Cost allocation schemes:
an asymptotic approach. Games and Economic Behavior 57, 63–72). Here we propose a characterization of
this solution using an adaptation of the balanced contributions axioms, used by Myerson (Myerson, R.,
1980. Conference structures and fair allocation rules. International Journal of Game Theory 9, 169-182) to
characterize the Shapley value in TU games. The new axiom, in the continuous case, is the natural
extension of the axiom used in the discrete case.
© 2006 Elsevier B.V. All rights reserved.

Keywords: Cost sharing; Cost allocation; Pseudo-average cost method; Price mechanism; Balanced contributions

JEL classification: D63; C71

1. Introduction

One of the most interesting applications of cooperative game theory is to solve problems of
cost allocation. Two models are frequently used to study these problems: the discrete model and
the continuous model.
Discrete cost allocation problems arise when goods are produced in indivisible units. A survey
of this problem and different solutions for it can be found in Moulin (1995). In that paper he
compares cost sharing methods for these problems: the Shapley–Shubik method (Shubik, 1962),

⁎Corresponding author.
E-mail addresses: carlos.santos@bs.ehu.es (J.C. Santos), elplajac@bs.ehu.es (C. Larrea).

0165-4896/$ - see front matter © 2006 Elsevier B.V. All rights reserved.
doi:10.1016/j.mathsocsci.2006.10.002
 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149 141

the discrete Aumann–Shapley method (Moulin, 1995, and Van Den Nouweland et al., 1995), the
serial cost sharing method (Moulin and Shenker, 1992; Moulin, 1995) and the pseudo-average
cost method (Moulin, 1995).1 All these methods are extensions of the Shapley value (Shapley,
1953) for TU games. Recently, other solutions have been studied for this model: fixed-path
methods (Moulin and Vohra, 2003), quasi-proportional methods and fixed-flow methods (Moulin
and Sprumont, 2005).
Continuum cost allocation problems arise when all outputs are perfect divisible goods and the
level of production can be measured by a real number. In this continuous context the best known
solution is the Aumann–Shapley price mechanism.2 Nevertheless, in the literature on cost sharing
problems various solutions have been proposed, such as the Shapley–Shubik method (Shubik,
1962), the serial cost sharing method (Moulin and Shenker, 1992), ordinal cost sharing methods
(Sprumont, 1998) and additive cost sharing methods (Friedman and Moulin, 1999).
The discrete model has an equivalent model in game theory; the so called multi-choice games.
These are games in which each player has a certain finite number of activity levels at which he can
play. In general, different players may have different possible levels, and the worth that a coalition
can obtain depends on the level at which each player in the coalition has decided to participate.
These games were introduced by Hsiao and Raghavan (1992). For these games, different
extensions of the Shapley value have been studied (this literature is surveyed in Calvo and Santos,
2000).
In this paper we study the pseudo-average cost method in the discrete and continuous models.
This solution has not been characterized in the literature on cost allocation problems, but there are
characterizations of it in the context of multi-choice games (that is, the discrete model). In
Albizuri et al. (2002) it is proved that the pseudo-average cost method coincides with a solution
for multi-choice games, the extended Shapely value, proposed by Derks and Peters (1993), and
studied by Klijn et al. (1999). They provide several characterizations of this solution, but the idea
of this solution and the axioms used are more appropriate when players are interested in the payoff
for each level. Given a cost allocation problem they assume that the solution is a (possibly
different) number for each player and each of his levels and the total value of a player is the sum of
these numbers (an interesting example is given in Klijn et al., 1999). In general, in cost allocation
problems the question is the total payoff of each player (good) or the per-unit cost of each good,
price, but the same price for each unit of the same good.
Here we use an extension of the balanced contributions axiom (Myerson, 1980) to provide an
axiomatic characterization of the pseudo-average cost method in the discrete case.
In the continuous model the pseudo-average cost method is defined (asymptotically) in Larrea
and Santos (2006), and there is no axiomatic characterization of this solution. We propose an
“adaptation” of the axiom used in the discrete case to the continuous case to characterize it. An
interesting open exercise is to characterize the pseudo-average cost sharing method by using
elementary principles and to compare it with the three well known solutions in this context: the
Aumann–Shapley method, the Shapley–Shubik method and the serial method (especially in the
continuous case).
The paper is organized as follows: the discrete case is studied in Section 2 and the continuous
case in Section 3.

1
Sprumont (1998) proposed a different extension of the serial method to the discrete-heterogeneous case. He called the
new proposal the “cross-subsidizing serial method” and the proposal by Moulin (1995) the “subsidy-free serial method”.
2
This concept stems from the works of Billera and Heath (1982) and Mirman and Tauman (1982), based on the work of
Aumann and Shapley (1974). See also Tauman (1988).
142 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149

2. The discrete case

Let U be the universe of goods and N = {1, 2,…, n} a finite set, ∅ ≠ N ⊂ U. For all qaRN , let
q aRN be defined by qiS = qi if i ∈ S and qiS = 0 if i ∈ N \ S, for all S ⊆ N; in the particular case S =
S

{ j}, we will write q j instead P of q{ j}; the vector qS aRS is defined by (qS)i = qi for each i ∈ S;
moreover we denote qðN Þ ¼ jaN qj . The unit vector is denoted by e ≔ (1,…, 1) and the zero
vector by θ = (0,…, 0). Given two vectors x, yaRN , x ≤ y means that xj ≤ yj, for all j ∈ N; and x b y
if x ≤ y and x ≠ y. The nonnegative integers are denoted as usually by ℤþ ¼ f0; 1; 2; N g, and
RNþ ¼ fxaRN : x⩾hg.
A discrete cost allocation problem (discrete CAP in the following) with a set of goods N is a
pair (q; C ), where qaℤNþ , and C is a real-valued function C : ℤNþ YRþ , such that C(θ) = 0, and C
( p) ⩽ C( p′) if p ⩽ p′. That is, we have n different goods produced in indivisible units. QN denotes
N
the set of all discrete CAPPn with set of goods N. A cost sharing method Pn on Q is a function
g : Q YRþ such that i¼1 gi ðq; CÞ ¼ CðqÞ. Note that by definition i¼1 gi ðh; CÞ ¼ CðhÞ ¼ 0
N N

and gi ðq; CÞ⩾0, for all q and i. Then ηi(θ; C ) = 0.

The pseudo-average cost method, for discrete CAP, is a linear solution, hence it is completely
determined once the distribution for a basis is known.3 A basis in the context of discrete CAP is
fCsq gsaℤ N , where
þ hbs⩽q

1; if sVt
Cs ðtÞ ¼
q
0; otherwise:

The pseudo-average cost method on discrete CAP is the linear solution defined on the basis
fCsq gsaℤ N by:
þ hbs⩽q

si
fi ðq; Csq Þ ¼ X :
sj
jaN

This solution was introduced in Moulin (1995). That paper characterizes a family of methods
satisfying additivity, dummy, demand monotonicity and cross monotonicity. Examples of
members of this family are the Shapley–Shubik method, the serial cost sharing method and the
pseudo-average cost Pmethod (Section 5 in Moulin, 1995). In particular, the pseudo-average cost
method holds that ni¼1 fi ðq; CÞ ¼ CðqÞ and fi ðq; CÞ⩾0. Nevertheless Moulin (1995) does not
offer a characterization of this method.
Although Klijn et al. (1999) offer three characterizations of the pseudo-average cost method
(of the equivalent solution in multi-choice games) based on the balanced contributions property,
there is no relation between them and the axiom of mean-balanced contributions that we introduce
in this paper. The reason is that they consider the solution of a multi-choice game, ηi(q; C ), as the
sum of ηiki = (q; C ), ki = 1,…, qi, (possibly ηiki (q; C ) ≠ ηihi (q; C ), if ki ≠ hi) and the axioms are
formulated taking into account only these numbers ηiki (q; C ). Hence it is not possible to translate
their axioms to this context.
The axiom that we propose is a fair-marginal rule that extends the balanced contributions
axiom to this context. Myerson (1980) characterizes the Shapley value with efficiency and
balanced contributions. Using an extension of this axiom, Calvo and Santos (2000, 2001, in press)
characterize the discrete Aumann–Shapley method on discrete CAP, the Aumann–Shapley prices

3
Of course, the domain QN is not a vectorial space but it contains the basis.
 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149 143

on mixed-cost allocation problems and the (subsidy free) serial cost method on discrete CAP.
Here we propose another extension of this axiom and the natural translation to continuous CAP.
Let (q; C ) ∈ QN be a discrete CAP and let η be a cost sharing method on Q N.
Axiom 1. Mean-balanced contributions.
X
qj X
qi
ðgi ðq; CÞ−gi ðq−aj e j ; CÞÞ ¼ ðgj ðq; CÞ−gj ðq−ai ei ; CÞÞ;
aj ¼0 ai ¼0

for all {i, j} ⊆ N.

Note that for q = e this coincides with the natural translation to this context of the balanced
contributions axiom. Here, on the left-hand side we compute the sum of j's contribution to i's
total cost at level q of production, when we pass to produce all possible intermediate levels
between 0 to qj − 1 units of good j. The axiom requires the sum of these marginal contributions for
each pair of goods to coincide.
In Calvo and Santos (2000) the extension of this axiom to characterize (jointly with the null
level property, that is ηi (q; C ) = 0 if qi = 0) the discrete Aumann–Shapley method on discrete
CAP is formulated as follows

qj d ½gi ðq; CÞ−gi ðq−e j ; CÞ ¼ qi d ½gj ðq; CÞ−gj ðq−ei ; CÞ;

for all (q; C ), and {i, j} ⊆ N, such that qi ≠ 0 ≠ qj. In this formulation, only the marginal
contributions at the “final” level of production (the change when producing a unit less) are
compared for each pair of goods.
The Shapley–Shubik solution can also be characterized by using the following extension of
the balanced contributions axiom (the change from producing a good to not producing it)

gi ðq; CÞ−gi ðqN⧹f jg ; CÞ ¼ gj ðq; CÞ−gj ðq N ⧹fig ; CÞ;

for all (q; C ), and {i, j} ⊆ N.

Finally, the (subsidy free) serial cost method is characterized (Calvo and Santos, in press) with the
null level property, the serial property and the restricted balanced contributions:if qi = qj N 0, then

gi ðq; CÞ−gi ðq−e j ; CÞ ¼ gj ðq; CÞ−gj ðq−ei ; CÞ:

Theorem 1. A cost sharing method η on QN satisfies mean-balanced contributions if and only if

η = ζ.
Proof. First we prove unicity. From the mean-balanced contributions axiom we have that
X
qj X
qi
ðgi ðq; CÞ−gi ðq−aj e j ; CÞÞ ¼ ðgj ðq; CÞ−gj ðq−ai ei ; CÞÞ:
aj ¼0 ai ¼0

Obviously, for aj = 0 and ai = 0 both terms are zero; hence summing up in j, j ≠ i,

2 3 " #
X X
qj X X
qi
4 ðgi ðq; CÞ−gi ðq−aj e j ; CÞÞ5 ¼ ðgj ðq; CÞ−gj ðq−ai ei ; CÞÞ :
jaN⧹fig aj ¼1 jaN⧹fig ai ¼1
144 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149

Adding qi ·ηi(q; C) on both sides

X X
qj X X X
qi
qðN Þd gi ðq; CÞ− gi ðq−aj e j ; CÞ ¼ qi d gj ðq; CÞ− gj ðq−ai ei ; CÞ:
jaN⧹fig aj ¼1 jaN jaN⧹fig ai ¼1

ð2:1Þ

From budget balance,

X
qi d gj ðq; CÞ ¼ qi d CðqÞ;
jaN

and
X X
qi X
qi
gj ðq−ai ei ; CÞ ¼ ½Cðq−ai ei Þ−gi ðq−ai ei ; CÞ:
jaN⧹fig ai ¼1 ai ¼1

Using these equalities in Eq. (2.1)

X X
qj X
qi X
qi
qðN Þd gi ðq; CÞ− gi ðq−aj e j ; CÞ ¼ qi d CðqÞ− Cðq−ai ei Þ þ gi ðq−ai e j ;CÞ;
jaN⧹fig aj ¼1 ai ¼1 ai ¼1

and rearranging

1 Xi 1 X Xj
q q
qi
gi ðq; CÞ ¼ CðqÞ− Cðq−ai ei Þ þ g ðq−aj e j ; CÞ: ð2:2Þ
qðN Þ qðN Þ a ¼1 qðN Þ jaN a ¼1 i
i j

Taking into account that all cost sharing methods satisfy ηi(θ; C ) = 0, the above expression
recursively determines a unique cost sharing method.
To conclude the proof it is sufficient to verify that ζ satisfies the mean-balanced contributions
axiom. Taking into account the linearity of expression (2.2) (with respect to the cost function) and
the linearity of the pseudo-average cost method, it is sufficient to prove that ζ satisfies the axiom
on the basis fCsq gsaℤ N .
þ hbs⩽q
To see this, let θ b s ≤ q, then

X
qj
si Xj q
s
½fi ðq; Csq Þ−fi ðq−aj e j ; Csq Þ ¼ qj d X − Xi Csq ðq−aj e j Þ:
aj ¼1 sj aj ¼1 sj
jaN jaN

Taking into account that Csq(q − aje j) = 1 ⇔ qj − aj ⩾ sj, and this holds in qj − sj cases, the last
expression is equal to

si si si d sj
qj d X − X ðqj −sj Þ ¼ X ;
sj sj sj
jaN jaN jaN

hence ζ satisfies the axiom on the basis required and the proof is complete. □
 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149 145

3. The continuous case

A continuum CAP with a set of goods N is a pair (z; F ), where zaRNþ and F is a real-valued
function F : RNþ YRþ , such that F(θ) = 0, and F(x) ⩽ F(x′) if x ⩽ x′. That is, we have n different
goods produced in totally divisible units. PN denotes the set of all continuum P CAP with set of
n
goods N. A cost sharing method
Pn on P N
is a function W : P N
YR N
þ such that i¼1 Wi ðz; FÞ ¼
FðzÞ. Note that by definition i¼1 Wi ðh; FÞ ¼ FðhÞ ¼ 0 and Ψi(z; F) ⩾ 0, for all z and i. Then
Ψi(θ; F) = 0.
For these problems, the well known Aumann–Shapley method, Φ, is defined by4
Z 1
AF
Ui ðz; FÞ ¼ zi d ðtzÞdt:
0 Axi

In Larrea and Santos (2006) a continuum CAP is considered as the limit of a sequence of
discrete CAP; to these discrete problems a linear solution is applied, and taking the limit a
solution for the original continuum CAP is obtained.
m
Given a continuum CAP, (z; F ), and k m aℤNþ ; limmYl kim ¼ l, the discrete CAP, (k m; F z,k ),
is defined by
 
m s1 sn
F z;k ðsÞ ¼ F z1 ; N ; z n ; for all hV sV k ; saℤþ :
m N
k1m knm

For each solution different regularity conditions are needed on the cost function. In this way
several asymptotic results are shown: for the Shapley–Shubik method, for the serial method and for
the pseudo-average method. A limit result for the Aumann–Shapley method is proved in Calvo and
Santos (2000).
In the case of the pseudo-average cost method, that is, applying this solution to the discrete
problems and taking the limit, a new cost sharing method on continuum CAP is obtained. As in the
serial method, the asymptotic result only holds for a particular type of problems and sequences. The
continuum CAP, (z; F), must meet the requirement that ai zj = aj zi, for some ai, aj aℤþ , and all i,
j ∈ N. The idea of the sequences is that if in the continuous case aizj = ajzi, then in the discrete version
it must happen that zikjm = zjkim for all k m. That is, the ratios between the levels of production in the
continuous and discrete case must be equal.
An important problem in continuous CAP is the regularity conditions of the cost function. In
this paper we restrict our set to the following domain:
Given (z; F) ∈ PN, the cost function F must have continuous partial derivatives of n-order with
respect to z.5 Denote by ΩN this subset of PN.
R zi R zi
Notation. Given T ⊆ N, T = {i1,… i|T |}, the integral 0 1 : : : 0 jTj 1dxijTj: : : dxi1 will be denoted by
R AjT j F AjT j F
½0;zT  1dxT , and Axi N Axi by AxT .
1 jT j

4
It is assumed that F is continuously differentiable on ½h; z ¼ fxaRNþ : hV xVzg. Also note that the formula is a revenue
not a price.
5
Although the formula of the pseudo average cost method can be applied on minor regularity conditions, for example, the
pffiffiffiffiffiffiffi
formula can be applied to cost functions such as Fðx; yÞ ¼ xd y.
146 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149

For continuum CAP, we will call the (asymptotic) solution obtained in Larrea and Santos the
pseudo-average cost method. We denote it by ϕ. It is defined by

XZ x AjT j F T
/i ðz; FÞ ¼ Xi ðx Þd xT ;
T pN ½0;zT  xj AxT
T ji jaT

for each (z; F ) ∈ Ω N.

PnNote that this method is the limit of 6the (discrete) pseudo-average method, hence it satisfies
i¼1 /i ðz; FÞ ¼ FðzÞ and ϕi (z; FP) ⩾ 0.
We include a general proof of iaN /i ðz; FÞ ¼ FðzÞ:7
X Xn XZ x AjT j F T X XZ x AjT j F T
/i ðz; FÞ ¼ Xi ðx Þd xT ¼ Xi ðx ÞdxT
iaN i¼1 T pN ½0;zT  xj AxT T pN iaT ½0;zT  xj AxT
T ji
X jaT jaT

XZ XZ
xi
AjT j F T AjT j F T
¼ X
iaT
ðx ÞdxT ¼ ðx ÞdxT
T pN ½0;zT  xj AxT T pN ½0;zT 
AxT
XX jaT
X
¼ ð−1ÞjT⧹Sj Fðz S Þ ¼ ð1−1ÞjN⧹Sj Fðz S Þ ¼ FðzÞ:
T pN SpT SpN

Now we characterize the pseudo-average cost method. We will consider only sufficiently
differentiable solutions Ψ. More precisely, it is required that if (z; F ) ∈ Ω N then the solution must
have continuous partial derivatives of n-order with respect to z. We denote by CN the set of all
cost sharing methods satisfying this condition of regularity. The axioms that we use are the natural
extension of the mean-balanced contributions axiom to this context and an axiom of null cost for
goods with level of production 0. The interpretation of the mean-balanced contributions axiom is
the same as in the discrete case, with (finite) sums being changed to integrals (infinite sums). Let
(z; F ) ∈ Ω N and let Ψ ∈ CN be a cost sharing method on Ω N.
Axiom 2. Mean-balanced contributions.
Z zj Z zi
½Wi ðz; FÞ−Wi ðz−yj e j ; FÞdyj ¼ ½Wj ðz; FÞ−Wj ðz−yi ei ; FÞdyi ;
0 0

for all {i, j} ⊆ N.

Axiom 3. Null level property.

Wi ðz; FÞ ¼ 0; if zi ¼ 0:

Theorem 2. A solution Ψ on Ω N, Ψ ∈ CN, satisfies the mean-balanced contributions axiom and

the null level property if and only if Ψ = ϕ.

ai zi
6
In the case of p , for all ai ; aj aℤþ the positivity holds from the density of rational number and the continuity of the
aj zj
integral.
7
This may be useful if we are interested in a general model, not only in non-decreasing functions.
 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149 147

Proof. First we show that the pseudo-average cost method satisfies the axioms. It can be shown
immediately that it meets the null level property. To see that ϕ satisfies the mean-balanced
contributions axiom,
Z zj Z zj
½/i ðz; FÞ−/i ðz−yj e ; FÞdyj ¼ zj d /i ðz; FÞ−
j
/i ðz−yj e j ; FÞdyj
0 0
XZ x AjT j F T
¼ zj d Xi ðx ÞdxT
T pN ½0;zT  xh AxT
Tji haT
Z X Z

ð Þ
zj
x AjT j F T
− Xi ðx Þd xT dyj
½0;zT 
0 TpN xj Vzj −yj xh AxT
T ji haT

XZ x AjT j F T
¼ zj d Xi ðx Þd xT
T pN ½0;zT  xh AxT
T ji haT

X Z xi AjTj F T
− ðzj −xj Þ X ðx Þd xT −zj
TpN ½0;zT  xh AxT
T tfi;jg haT

XZ x AjT j F T X Z xj d xi AjT j F T
 Xi ðx ÞdxT ¼ X ðx ÞdxT ;
½0;zT  xh AxT TpN ½0;zT  xh AxT
T pN
T ji haT T tfi;jg haT
jgT

hence it satisfies this axiom.

Uniqueness. Let Ψ be a cost sharing method on ΩN, Ψ ∈ CN, satisfying the mean-balanced
contributions axiom and the null level property, and (z; F ) ∈ ΩN. Taking derivatives with respect
to z1,…, zn in the mean-balanced contributions axiom we obtain

An Wi ðz; FÞ An Wj ðz; FÞ
zj ¼ zi :
Az Az
Taking into account that ϕ also satisfies this axiom, we have

An /i ðz; FÞ An /j ðz; FÞ
zj ¼ zi :
Az Az
Then

An ðWi ðz; FÞ−/i ðz; FÞÞ An ðWj ðz; FÞ−/j ðz; FÞÞ
zj ¼ zi :
Az Az
Hence

X
n
An ðWi ðz; FÞ−/i ðz; FÞÞ X n
An ðWj ðz; FÞ−/j ðz; FÞÞ
zj ¼ zi :
j¼1
Az j¼1
Az
148 C. Larrea, J.C. Santos / Mathematical Social Sciences 53 (2007) 140–149

And, by budget balance,

X
n
ðWj ðz; FÞ−/j ðz; FÞÞ ¼ 0:
j¼1

Then,

An Wi ðz; FÞ An /i ðz; FÞ
¼ :
Az Az

This implies that

Z Z
An Wi ðx; FÞ An /i ðx; FÞ
dx ¼ dx:
½0;z Ax ½0;z Ax

Equivalently,
X X
ð−1ÞjN⧹T j Wi ðzT ; FÞ ¼ ð−1ÞjN⧹T j /i ðzT ; FÞ: ð3:1Þ
TpN TpN

The result follows by applying induction on |N|.

If |N | = 1, from Eq. (3.1)

ð−1ÞWi ðh; FÞ þ Wi ðz; FÞ ¼ ð−1Þ/i ðh; FÞ þ /i ðz; FÞ;

and by definition of a cost sharing method, Ψi(θ; F ) = 0 = ϕi(θ; F ), hence Ψi(z; F ) = ϕi(z; F ).
If |N | N 1, let ∅ ≠ T ⊂ N and (zT; G) be the continuum CAP defined by: G(xT) = F(xT) for each
xaRN ; h⩽ x⩽ z. Note that xT aRT and F and G are fixed. Let ϕ′ be the function defined on any
continuum CAP (zT; G) by ϕ′(z i T; G) = ϕi(z ; F ) for each i ∈ T. Analogously define Ψ ′. It is easy
T

to check that Ψ ′ and ϕ′ satisfy the null level property and the mean-balanced contributions
axiom. Then, by the induction hypothesis, ϕ′(z i T; G) = Ψi′(zT; G). Hence ϕi(z ; F ) = Ψi(z ; F ).
T T

Then from Eq. (3.1) it follows that ϕi(z; F ) = Ψi(z; F ), and the proof is complete. □

Acknowledgements

This research has been partially supported by the University of the Basque Country (project
UPV/EHU 00031.321-15352/2003) and DGES Ministerio de Educación y Ciencia (project
BEC2003-08182).

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