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1423class7 - 14.23 Government Regulation of Industry Class...

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Unformatted text preview: 14.23 Government Regulation of Industry Class 7 MIT & University of Cambridge 1 Outline Multi-product monopolists Regulation in practice electric utilities Regulated Rate levels Rate structures Peak load pricing De-regulation in electricity markets 2 Natural monopoly revisited Economies of scale, C( Q)< C(Q), in production and economies of scope interact. It is possible that economies of scale combine with diseconomies of scope to make multi-product monopoly inefficient. Similarly economies of scope, C(Q 1 ,Q 2 )<C(Q 1 )+C(Q 2 ), with diseconomies of scale may make multi-product monopoly inefficient. Thus integration of electricity transmission and generation (in tradition electric utility monopolies) may not be justified by proof of economies of scope. 3 Regulation in Practice Company must get changes in rates (or regulated component of rates) approved by regulator. Company will initiate a rate hearing before the state Public Utilities Commission (PUC) if it wants to raise rates (on grounds of cost increases, e.g. due to inflation). Consumers and the Commission may initiate rate hearing to reduce rates if rate of return too high (due to cost falls, efficiency gains etc). FERC involved in regulation of interstate transmission and in national policy setting. 4 Fair and Reasonable Rates Allowed Revenue ( R )= Expenses (E)+ Fair rate of return. Fair return = allowed cost of capital (s)* regulatory asset base (or rate base) (RB). Two problems: Rate level (i.e.the allowed revenue) Rate structure (i.e. permissible price discrimination which achieves rate level) 5 Rate Level R=E+s*RB E: company submits detailed cost breakdown of regulated company business. Occasionally excessive expenses can be disallowed e.g. CA nuclear plant, only 20% of cost allowed (company could have put in cheaper alternative technology) RB: usually original cost of capital. s: established in rate hearings and precedent (c.10.5%). 6 Rate Base Different ways of calculating the rate base are possible: Original cost , problematic if there is inflation, as current costs do not reflect LRMC, this gives incentives to over-consume....
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1423class7 - 14.23 Government Regulation of Industry Class...

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