ISSN:
1467-999X
Source:
Blackwell Publishing Journal Backfiles 1879-2005
Topics:
Economics
Notes:
The principal question addressed in this paper concerns the optimal price profile for a regulated public utility where demand is stochastic. Through the introduction of rationing costs and a rate-of-return constraint, marginal revenue will be approximately equated to the cost associated with satisfying the last unit of consumers’demand. This has significant implications for capacity expansion. Namely, capacity is added to keep the risk of failure minimal. As a result, to the extent that the associated costs are higher for the last unit of capacity, a higher marginal revenue and hence price will result. That is, if the marginal unit of capacity has a high operating and delivery cost and low capital cost with high reliability and consequent high total cost (e.g., an internal combustion peaking unit), the indicated result follows.Consequently, there is a direct trade off between the level of risk of failure and marginal revenue. This provides a rationalization for the existence of the price differential between firm and interruptible customers. Finally, if the firm is contrained to earn a fair return on its capital investment, it will set prices to favor the consumers generating the expansion in capacity.
Type of Medium:
Electronic Resource
URL:
http://dx.doi.org/10.1111/j.1467-999X.1979.tb00254.x
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