Regulatory Preferences and Two-Part Tariffs: The Case of Electricity

Abstract

The purpose of this paper is to develop and demonstrate a method for deriving and testing regulatory preferences within and across customer classes, and to assess the impact of these preferences on price structures and regulatory effectiveness in the electric utility industry. The method extends a technique described in both Nelson and Ross for uncovering interclass preferences in a uniform price framework [24; 33; 34]. By employing a two-part tariff framework, the extension enables the derivation of both interclass and intraclass preferences. Intraclass preferences can be derived in a two-part tariff framework because regulators can discriminate not only between customer classes, as with uniform prices, but also within a customer class. Two-part tariffs are also introduced because actual price structures in the electric utility industry are better approximated by two-part tariffs than by uniform prices.' Models of optimal two-part tariffs, particularly those of Schmalensee, and Sherman and Visscher, are extended to allow regulatory preferences to vary across and within heterogeneous customer classes [36; 37; 13; 27; 11; 25; 19; 18; 22].2 These variable preferences are incorporated into a weighted social surplus function which regulators are assumed to maximize. Given this model of regulatory behavior, preference weights can be derived for the electric utility industry with information on the markups of both per-unit prices over marginal costs of kWh output and fixed charges over the marginal costs of customer connection, and on output and connection demand elasticities.