Implications of dynamic demand functions for public utility pricing and regulatory policy
A measure of intertemporal consumer surplus is used to formulate the objective function in a model of welfare maximizing public utility which serves a market with a dynamic demand structure. An important advantage of the model structure utilized is that it specifies dynamic demand using the same distributed lag functional form as is often used in empirical work. The model is formulated as an autonomous, infinite horizon optimal control problem. An analysis of the first order necessary conditions indicates that, under steady-state conditions, a policy of marginal cost pricing should be followed. The basic model is modified by adding a breakeven constraint to produce a dynamic version of the well known Ramsey pricing rule. A comparison of the dynamic rule with that derived for the static case indicates that significant errors can result if the latter is applied in cases where demand exhibits a dynamic structure. Finally, some implications of the dynamic demand phenomenon for the regulation of public utilities are considered. It is shown that, if two utilities serve markets with equal short-run price elasticities, but one market has a dynamic demand structure and the other does not, then the difference between profit maximizing prices and Ramsey-optimal prices will be smaller in the dynamic market.
- Research Organization:
- Johns Hopkins Univ., Baltimore, MD (USA)
- OSTI ID:
- 5744432
- Country of Publication:
- United States
- Language:
- English
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Related Subjects
290200* -- Energy Planning & Policy-- Economics & Sociology
296000 -- Energy Planning & Policy-- Electric Power
DEMAND FACTORS
ECONOMIC ANALYSIS
ECONOMIC ELASTICITY
ECONOMICS
MARGINAL-COST PRICING
MATHEMATICAL MODELS
PRICES
PUBLIC UTILITIES
REGULATIONS