Pricing Public Utility Service: Electricity

Essential good or service. Often provided to the general population by a government entity but
deregulation might allow large private firms to operate in such industries.

Characterized often by economies of scale.

The objectives of public policy in providing a good or service of this nature are :

- ‘Equity’ in service provision or in consumer access

- Support to low income population
- Incentivize efficiency on the production and distribution side
- Incentivize sustainability and innovation on the production and distribution side
- Serving a stochastic or variable demand (peak and non-peak demand)
- Incentivize sustainability and efficiency of the demand side
- Sponsor the cost of production and distribution
- Account for the externality of carbon emissions

Should price equal MC? If surplus from trade were to be maximized, then this is what should be
prescribed. However, with economies of scale and MC lower than AC, at such a price the
producer/seller will be making a loss.

Implications would be none/very low tolls on highways; almost free electricity, water, metro and
public transport service. As long as there is no overcrowding.

Ramsey pricing: Maximize surplus/welfare from service provision subject to the constraint of
balancing the budget or covering the total cost of service provision. If the public utility is selling
multiple goods/services or selling the same good/service to different market segments, then Ramsey
pricing results in:

p i−M C i k
= ;k>0
pi ηi
The above is concerned with single price for each product in each market.

Coase: Incremental cost of extending service to a consumer must be paid by the consumer in turn.

Two part pricing: a fixed charge/price that pays to be connected to the grid; and a variable (per unit)
consumption charge/price. This kind of pricing more or less ensures that the utility’s net earnings do
not vary too much with load/demand.

However, this is not progressive in income consumption. To make this progressive in

income/consumption, there can be two/multiple variable (per unit) consumption prices; these are
called increasing block rates. The fixed or connection charge can then be lower than in the two part
pricing above. Illustrate on a diagram.

Because the fixed charge is now lower, changes in load will now affect the utility’s net earnings more
than in the simpler two part pricing structure.

Notice that the characteristics and goals of such a good/service/market go beyond what we have
seen theoretically as simply static profit maximization. Here there is a dynamic stochastic market,
with goals of encouraging efficiency and conservation, but also there is often a positive correlation
between income/WTP and consumption such that giving quantity discounts is neither the main
motive and nor does it align well with incentivizing efficiency of consumption.
To better ensure that revenue covers the cost of service provision, utilities can adopt ‘Decoupling’.
The idea here is to disassociate net earnings from the load or sale of the good/service. Rates are
adjusted for each load level to meet some revenue or net earnings target. This ensures that the
utility is always solvent but does so at the cost of more volatile pricing.

Having multiple variable charges or block rates can sometimes lead to high income consumers
benefiting from lower prices meant for low income consumers.

For example, in places where some consumers also have rooftop solar panels installed in their
homes and buy only the remainder (over and above what they themselves produce in solar) from
the grid. Or high income consumers have energy efficient homes and electric appliances. These
consumers then become low consumption users and thus receive the lower price, disrupting the
progressive nature of pricing. This can however be defended as incentivizing renewable energy
and/or incentivizing energy efficiency, and maybe then its being at the cost of progressive pricing still
makes it worthwhile.

The problem is larger if high income consumers benefit from lower rates, meant for lower income
consumers, without generating their own renewable energy or without being energy efficient. Think
of vacation homes of the rich, etc. And if low income consumers are unable to keep their
consumption low because of their low quality housing, etc.

Separating low income families from others on the basis of income and offering them a lower price
based on this distinction is of course a solution to this problem.

It is often difficult to understand whether consumers respond to changes in marginal cost or average
cost of consumption, or to total bill amount. Or whether consumers even understand or are aware
of the tiers in the rate structure at all. And maybe the lack of understanding of rate structure is also
rational given consumers do not know how to use that information in their consumption.
Responding to total bill amount might be simpler and more practical.

Delhi subsidies: free electricity till 200 units of usage. 50% subsidy for usage between 201-400 units.

Now households who want this need to apply for it. Price discrimination? Which degree? Can people
not targeted by the subsidy avail it? Honour system. But also according to behavioral economics the
psychological cost of ‘opting in’ should deter those who do not need it; people have a tendency to
simply stay with whatever is the default option.

Peak load pricing.

https://www.bsesdelhi.com/documents/55701/92678/Tariff_Schedule_for_FY_2021_22.pdf/
e862f0b1-cbfe-2f63-84b1-e478c5021a0e?t=1633426006962

Subsidies and promotions to participate in energy efficient methods and/or sources.

https://mnre.gov.in/solar/schemes

https://www.solarsmiths.com/blog/knowledge/solar-subsidy-in-delhi-for-residential-and-group-
housing-societies/

References:

R.H. Coase, “The theory of public utility pricing and its application”, The Bell Journal of Economics and Management Science, Spring, 1970, 1, 1, pp 113-128.

Karier, Tom, “Utility Pricing and Public Policy”, The Electricity Journal, 28, 6, July 2015, pp 12-19.
https://eml.berkeley.edu/~train/regulation/ch4.pdf