Efficient pricing and flowthrough

Abstract

Introduction A key ingredient in most discussions of efficient pricing theory is the assumption that the regulated monopoly's customers are independent of each other. That is, it is assumed that the amount consumed by one customer has no impact on the surplus which can be earned by another customer. For this reason, it is possible (and convenient) to ignore interactions between consumers in designing efficient prices. In reality, there are many reasons why interactions between consumers could be important; in such cases, efficient pricing rules should take account of them. One especially important type of interaction occurs when the utility sells both to business customers and residential consumers. Residential consumers buy the utility's services as final products to be consumed. The business customers buy the utility's services as inputs into their own production processes, which produce outputs that they sell to other businesses and to final consumers, including, possibly, the utility's residential customers. The prices that the utility's business customers charge for the goods and services which they produce link their welfare to those of the utility's residential customers, who buy both the service of the utility and the outputs produced by the utility's business customers. Individual business users' profits are linked to the extent that they compete with each other. This type of interaction also occurs when a utility sets a nonuniform price schedule for business customers. Changes in marginal prices at given points on the schedule will affect total outlay for firms which consume larger amounts of the utility's services. This, in turn, affects prices in these industries.