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Problem of second best and the efficient pricing of electricity

Technical Report ·
OSTI ID:6432585
;
The feasibility and potential usefulness of extending the economic welfare theory of second best to electricity pricing is examined. The theory of second best concerns the efficiency of the economy when some products are not priced at maginal cost. It has been suggested that this theory be extended to develop rules for pricing electricity at other than marginal-cost prices since other portions of the energy sector are not characterized by marginal-cost pricing. Such deviations of price from marginal cost for electricity may result in an economically more-efficient allocation of resources (second-best allocation) and social gains. However, this study concludes that formal extensions of second-best theory would contribute little, if anything, as a practical guide for the ratemaker or regulator. Such analysis would require impractically elaborate and specialized assumptions, while second-best interventions to the existing state of affairs of the market are likely to entail considerable setup and maintenance costs. Given this negative conclusion regarding the practicality of second-best allocations, what pricing rule should be employed in the regulated industries. The authors point out that marginal-cost pricing in isolated cases cannot be supported by conventional welfare analysis alone. However, they defend marginal-cost pricing on the grounds that it accords with business-like behavior in other sectors of the economy and that such behavior has produced economic results which must be judged satisfactory by elementary survival tests.
Research Organization:
Electric Power Research Inst., Palo Alto, CA (USA)
OSTI ID:
6432585
Report Number(s):
EPRI-EA-1852-SR; ON: DE81903317
Country of Publication:
United States
Language:
English

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Related Subjects

29 ENERGY PLANNING, POLICY, AND ECONOMY
296000* -- Energy Planning & Policy-- Electric Power
CHARGES
COST
ELECTRIC POWER
ELECTRIC UTILITIES
MARGINAL-COST PRICING
MARKET
POWER
PRICES
PUBLIC UTILITIES
RATE STRUCTURE