Fixing Retail Electricity Prices

Lecture 1

Economic efficiency requires marginal price equal marginal cost at all points in time.
Costs vary considerably over time as demand changes. But consumers typically face a single flat price.
How much would things change if consumers faced higher prices during peak demand windows? The answer depends on their price elasticity, which is typically estimated to be quite inelastic.
Why are consumers so price inelastic? One hypothesis is that they don’t know how much electricity they are using. We read an academic paper that studies this using an experiment.

Read Jessoe and Rapson (AER 2014)
Come to class prepared to discuss the following questions:
1. What is the research question?
2. Why do the authors need to use an experiment to answer it?
3. Explain the experimental setup in your own words. What are the different experimental groups?

Practice drawing the deadweight loss from flat (non time-varying) electricity prices.

Draw a convex (increasing at an increasing rate) marginal cost curve.
Draw two demand curves, peak and off peak.
Label the efficient quantity and price.
Now determine how much would be consumed in each period if consumers face the average price in each period.
Draw the associated deadwieght loss.
Now vary: the slope of the demand curves and then, separately, the slope of the supply curve. What happens to dead weight loss as these become more/ less elastic?

Economic efficiency requires marginal price equal marginal cost. But the electricity system involves many fixed costs. How should these be recovered?
An efficient option is to charge fixed fees to consumers. But this has drawbacks.
Review various options for pricing different consumers differently.
Combined with the fact that externalities are not priced, this can lead to prices that are too high or too low.
- Borenstein and Bushnell look at the data and find that prices are too high in some parts of the country and too low in others.

Read “The Economics of Fixed Cost Recovery by Utilities” by Severin Borenstein (pp 1-8 required; the whole thing is recommended)
Read this blog post on whether utilities are getting this right in the US.
- Full article describing this research is here if you are interested.

Read the section “Rate Structure” (pages 443 - 447) in Chapter 12 of the textbook, “Economics of Antitrust and Regulation” by Viscusi, Henderson and Vernon (henceforth VHV).
Then do this practice problem finding the change in prices and incidence of a tax. Solutions will be posted next week.
- Solutions are here

Read the first 6 pages (429 - 435) in VHV Chapter 12.
Listen to the Heatmap podcast episode “Utility Regulation Sucks” (approx 1 hour)
- Pay attention to:
  - What’s driving increases in electricity prices?
  - How are utility prices set? How does this differ from a normal market?
  - What challenges does this pose?

Do this practice problem exploring the welfare of different outcomes possible under a natural monopoly.
- Solutions are here

Although grid scale solar is much cheaper, solar policy in the US has focused on residential solar. We review the pros and cons of these.
We review the private and public economics of the private decision to install residential solar panels. By modeling these incentives, we can understand how different solar policies work, and which might be more or less effective.
One reason to invest in solar is to reduce your electricity bill. But this can create a problem for utilities. We discuss the “solar cost shift” and how it can be addressed.