This doesn’t apply in all countries. In UK for instance, it is common to have a standing charge (flat fee per day) as well as a usage charge (fee per kWh). Or some utilities charge a high price for the first few kWh, and then a lower price for subsequent kWh, which has a similar effect. See here for some details.
My perspective is US-centric, but from what I’m aware the per kWh price in most countries for most people is well above the marginal costs. Many places do have a daily or monthly charge but that tends to be $10 or less—not even close to high enough to recover all the fixed costs associated with a customer. Looking through some of the Scottish Power rates that you linked to, the daily charge doesn’t get much higher than 30p. That helps mitigate the issue a bit, but it’s still there. In that case, retail kWh prices—after the standing charge—is still over 10p / kWh. Wholesale rates look like they’re 4.5p in the UK (which should be a good proxy for short run marginal costs) so there’s still a big gap.
Even where there is a single price (a price per kWh) it is not true that the “correct” market price is just the marginal cost...
As far as I’m aware, economic theory says the “correct” price for electric utilities is lower than where the actual price is. It’s probably easier to visualize on a graph like this one. (I’m saying the difference between Pf and Pr, at least in some cases, may be higher than the externality, which is a real-life example of what the op is talking about). If that’s not standard economic theory though let me know as it’s an area of interest to me.
The market correction mechanism you described works for most industries but electric utilities are typically treated as natural monopolies, the optimal number of suppliers is one. But even if that ’s not true (i.e. it’s not actually optimal), in many places regulation only allows one supplier so the market forces described couldn’t work. The result is that the average /kWh price customers pay is higher than the average marginal costs (optimal society price) and it continues indefinitely because new firms can’t come into the market. There isn’t large profits made though because they’re pricing at the regulated price (at the average total cost) and not at the monopoly price (again, easier to visualize on the graph linked to above).
It’s probably easier to visualize on a graph like this one. (I’m saying the difference between Pf and Pr, at least in some cases, may be higher than the externality, which is a real-life example of what the op is talking about).
I think that, strictly, Stuart was arguing that the difference between Pm and Pf exceeds the externality cost, which may well be true. However, politically it is of course much easier to force a polluting monopoly to lower its price (to Pf) than to subsidise said monopoly still further. It is also economically more efficient (there are better things to do with public money).
You may also be right that the externality cost exceeds the difference between Pf and Pr—referring to the UK numbers, does the externality actually work out at less than about 5p per kWh? Even if it does, I’d argue that it is unrealistic to expect the price to drop to Pr and stay there indefinitely (while the suppliers go broke).
The “Correct” price for electricity is one price to be connected to the grid and several more relating to one’s power used, power factor, peak demand, and the like.
The average price paid is lower than the “correct” price, because charging the “correct” price adds lots of measuring and billing costs. It’s better to allow some subsidizing to be happening than to spend more just to make sure it isn’t.
An easy way to do it would be to charge the “correct” marginal cost for all kWh and have a separate fixed fee. My water bill is something like $50 fixed and then a small amount for the water I use after it; the electric bill could work the same. Ronald Coase argued that here
Commercial meters have priced kW for a long time and I think the reason residential didn’t was more along the lines of they’re more homogeneous than the meter costs. But either way, it seems everyone is getting smart meters now and you could match it up to theory exactly if it were politically feasible.
The political problem is that some people would be charged more; regression to the mean suggests that those people would be the ones who currently pay the least. The people who pay the least are the people who use the least power.
In a proper cost-sharing setup, dividing the fixed cost of maintaining each portion of the grid among the people served by that portion of the grid, pricing would be fiendishly complicated and appear unfair: Consider ten rural houses roughly in a line sharing a single branch line from the distribution station: each of these houses would be charged equally for their use of the larger distribution network, but the first house would be charged with 1⁄10 the cost of maintaining the first segment of their shared circuit, the second house would be charged that plus 1⁄9 the cost of the second segment, and so forth.
Or is it: If someone builds an 11th house at the end of that line, and the added load requires that the first segment be upgraded (to a line with higher maintenance costs) to handle the additional load, how is that cost fairly distributed? (What if the 11th house is added in the middle of the line?)
A $X+$y/kWh system makes more sense, but there is no system which is perfectly fair and appears to be fair to most people.
The political problem is that some people would be charged more; regression to the mean suggests that those people would be the ones who currently pay the least. The people who pay the least are the people who use the least power.
Everything you say is true, but your implied argument is flawed (you are implicitly making an “all A are B, all C are B, therefore all A are C” argument). If we had a fixed fee, and were discussing the possibility of eliminating it, your argument would apply just as well.
Sorry- that made much more sense as a lead-in to the self-redacted segment where I pointed out that the higher-spending (and presumed higher-income) users were subsidizing the poor, and suggested that might be a feature.
I get the difference in country perspective, and the difference between a regulated local monopoly (which I believe you have in US) vs a market structure with a regulated distribution network, but a large choice of retail suppliers.
Incidentally, there are 6 large UK suppliers, and multiple smaller ones, so this is far from perfect competition, but also far from a monopoly. According to this report retail margins are about 7 per cent, and the previous margin was only about 3 per cent. Even in a “good year”, the big six suppliers are making an average profit of around £100 per year on an average bill of around £1400 per year. So if the retail price dropped to 9 pence per kWh as opposed to 10 pence per kWh, the firms would probably be making a net retail loss.
While the current profit margin probably does encourage entry, I can’t see any way that the retail price could drop to 4.5 pence per kWh and still allow a supplier to make a profit. It seems quite possible that a new supplier could start up offering 5 pence per kWh, and would rapidly grab market share: the fact that no-one in UK is trying that suggests that it just doesn’t stack up as NPV positive.
My perspective is US-centric, but from what I’m aware the per kWh price in most countries for most people is well above the marginal costs. Many places do have a daily or monthly charge but that tends to be $10 or less—not even close to high enough to recover all the fixed costs associated with a customer. Looking through some of the Scottish Power rates that you linked to, the daily charge doesn’t get much higher than 30p. That helps mitigate the issue a bit, but it’s still there. In that case, retail kWh prices—after the standing charge—is still over 10p / kWh. Wholesale rates look like they’re 4.5p in the UK (which should be a good proxy for short run marginal costs) so there’s still a big gap.
As far as I’m aware, economic theory says the “correct” price for electric utilities is lower than where the actual price is. It’s probably easier to visualize on a graph like this one. (I’m saying the difference between Pf and Pr, at least in some cases, may be higher than the externality, which is a real-life example of what the op is talking about). If that’s not standard economic theory though let me know as it’s an area of interest to me.
The market correction mechanism you described works for most industries but electric utilities are typically treated as natural monopolies, the optimal number of suppliers is one. But even if that ’s not true (i.e. it’s not actually optimal), in many places regulation only allows one supplier so the market forces described couldn’t work. The result is that the average /kWh price customers pay is higher than the average marginal costs (optimal society price) and it continues indefinitely because new firms can’t come into the market. There isn’t large profits made though because they’re pricing at the regulated price (at the average total cost) and not at the monopoly price (again, easier to visualize on the graph linked to above).
I think that, strictly, Stuart was arguing that the difference between Pm and Pf exceeds the externality cost, which may well be true. However, politically it is of course much easier to force a polluting monopoly to lower its price (to Pf) than to subsidise said monopoly still further. It is also economically more efficient (there are better things to do with public money).
You may also be right that the externality cost exceeds the difference between Pf and Pr—referring to the UK numbers, does the externality actually work out at less than about 5p per kWh? Even if it does, I’d argue that it is unrealistic to expect the price to drop to Pr and stay there indefinitely (while the suppliers go broke).
The “Correct” price for electricity is one price to be connected to the grid and several more relating to one’s power used, power factor, peak demand, and the like.
The average price paid is lower than the “correct” price, because charging the “correct” price adds lots of measuring and billing costs. It’s better to allow some subsidizing to be happening than to spend more just to make sure it isn’t.
An easy way to do it would be to charge the “correct” marginal cost for all kWh and have a separate fixed fee. My water bill is something like $50 fixed and then a small amount for the water I use after it; the electric bill could work the same. Ronald Coase argued that here
Commercial meters have priced kW for a long time and I think the reason residential didn’t was more along the lines of they’re more homogeneous than the meter costs. But either way, it seems everyone is getting smart meters now and you could match it up to theory exactly if it were politically feasible.
The political problem is that some people would be charged more; regression to the mean suggests that those people would be the ones who currently pay the least. The people who pay the least are the people who use the least power.
In a proper cost-sharing setup, dividing the fixed cost of maintaining each portion of the grid among the people served by that portion of the grid, pricing would be fiendishly complicated and appear unfair: Consider ten rural houses roughly in a line sharing a single branch line from the distribution station: each of these houses would be charged equally for their use of the larger distribution network, but the first house would be charged with 1⁄10 the cost of maintaining the first segment of their shared circuit, the second house would be charged that plus 1⁄9 the cost of the second segment, and so forth.
Or is it: If someone builds an 11th house at the end of that line, and the added load requires that the first segment be upgraded (to a line with higher maintenance costs) to handle the additional load, how is that cost fairly distributed? (What if the 11th house is added in the middle of the line?)
A $X+$y/kWh system makes more sense, but there is no system which is perfectly fair and appears to be fair to most people.
Everything you say is true, but your implied argument is flawed (you are implicitly making an “all A are B, all C are B, therefore all A are C” argument). If we had a fixed fee, and were discussing the possibility of eliminating it, your argument would apply just as well.
Sorry- that made much more sense as a lead-in to the self-redacted segment where I pointed out that the higher-spending (and presumed higher-income) users were subsidizing the poor, and suggested that might be a feature.
I get the difference in country perspective, and the difference between a regulated local monopoly (which I believe you have in US) vs a market structure with a regulated distribution network, but a large choice of retail suppliers.
Incidentally, there are 6 large UK suppliers, and multiple smaller ones, so this is far from perfect competition, but also far from a monopoly. According to this report retail margins are about 7 per cent, and the previous margin was only about 3 per cent. Even in a “good year”, the big six suppliers are making an average profit of around £100 per year on an average bill of around £1400 per year. So if the retail price dropped to 9 pence per kWh as opposed to 10 pence per kWh, the firms would probably be making a net retail loss.
While the current profit margin probably does encourage entry, I can’t see any way that the retail price could drop to 4.5 pence per kWh and still allow a supplier to make a profit. It seems quite possible that a new supplier could start up offering 5 pence per kWh, and would rapidly grab market share: the fact that no-one in UK is trying that suggests that it just doesn’t stack up as NPV positive.