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Pricing Reform for the Local Disco: Setting Rates That Will Support Distributed Generation

The Proposed Distribution Tariff
Fortnightly Magazine - July 1 2000

make customers better off?

A number of regulators and consumer advocates at the NARUC stakeholders meeting last March asked just this question. This idea is always difficult for non-economists, although most people have no trouble understanding that the thirsty tennis player is better off-i.e., has greater utility-consuming three bottles of water instead of only one . But let's examine this consumer surplus story further.

Consider the department store shopper who passes up a $50 shirt only to return to buy two shirts when the price is reduced to $30. From his behavior, we see that this shopper is better off (has greater utility) having spent $60 for two shirts than he would have been with one shirt at $50. (His choice to buy two shirts implies that his for one shirt was less than $50.) In a similar manner, the average household is better off using 1,429 kWh of electricity at 4.5 cents (for a total of $99.63) than it was buying 810 kWh for $71.79.

Will consumers just spend more so they can leave the lights on all night long? (They could, and if that is their informed preference for allocating resources, it cannot be deemed inefficient.) It is far more likely that prudent electricity consumers will their consumption outlays: Metaphorically, they will install fewer costly energy-saving light bulbs. This outcome is efficient and desirable. When electricity charges arbitrarily are set above cost, society subsidizes uneconomic purchases of energy-saving light bulbs; that is wasteful.

What about equity? Is it fair to collect an access charge to recover fixed network costs?

Regulators and consumer advocates traditionally have opposed raising the access charge to more fully recover fixed network costs. The opposition usually is based on equity concerns. Traditional fixed customer charges are imposed uniformly for all residential consumers under the theory that the so-called "customer costs" are independent of usage levels. Certainly some costs, such as meter reading and billing, are independent of usage, but these costs are small relative to the total cost of providing a customer with access to the grid. 11 The majority of the costs of maintaining access are tied to the distribution plant-a cost that varies with peak usage.


Spending More is Better?

Pricing reform for distribution service could boost consumption and total bills, but with a lower per-unit cost of energy, which adds to consumer surplus.

Consumer surplus marks the difference between price and a consumer's willingness to pay. The figure below shows that a tennis player, thirsty after a match, would be willing to pay $3 for a bottle of water. Having consumed that bottle, the player is less thirsty and would buy a second bottle only if the price did not exceed $2. The player then would be willing to pay $1.10 for a third bottle. The manager of the refreshment stand has no accurate way to gauge each customer's thirst and so cannot charge thirsty customers more. Instead, the manager sets a single, profit-maximizing price-$1.00-as shown by the red dotted line.

Our tennis player, having been willing to pay $3 for her