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Rate-Case Mania: Lessons for a New Generation

Fortnightly Magazine - February 2006
  • sound principles and practices;
  • Provide opportunities for stakeholder input;
  • Explore a full range of options;
  • Weigh complexity against simplicity; and
  • Phase-in big changes gradually by conducting small-scale pilots and experiments to gauge customer acceptance and load response and test-associated technologies.

It is important to monitor and evaluate outcomes of new rates and to modify rates as needed to meet changing utility and customer needs.

The best tariffs in the market place are multi-part tariffs that include an access charge (or customer charge), an energy charge, and a demand charge (for large customers). Such tariffs often embody time-of-use elements. In addition, they feature a block structure where the charge varies with usage.

More sophisticated tariffs also include an allowance for the customer’s willingness to pay for electricity, as measured by the price elasticity of demand. Such tariffs, based on a formulation that was originally developed in the theory of optimal taxation, are often called Ramsey tariffs. 4 They suggest that the prices vary by segment in inverse proportion to that segment’s price elasticity of demand. Ramsey pricing is controversial because it leads to markups over marginal costs that are highest for those customers whose demands are the least price responsive. Since such customers are often smaller customers, it raises issues of fairness and equity, even though the pattern of consumption that would flow from it is designed to maximize economic efficiency.

These are just some of the many issues to consider in regard to ratemaking and design.

 

Endnotes:

1. For a survey of such models, see Laffont, Jean-Jacques and David Martimort, The Theory of Incentives: The Principal-Agent Model, Princeton University Press, 2002.

2. Conversely, if the utility accrued losses consistently, it would become insolvent and unable to serve its customers.

3. This is discussed in detail in Jean Jacques Laffont and Jean Tirole, A Theory of Incentives in Regulation and Procurement, Cambridge: MIT Press, 1993.

4. Frank P. Ramsey, “A Contribution to the Theory of Taxation,” Economic Journal, 1927.

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