Long-run Marginal Cost Research Articles

Cost-effectiveness of family planning in India: the long-run average and marginal costs

An attempt was made to work out the actual costs (ACs) and marginal costs (MCs) of Indias family planning program over the 1956-57 and 1982-83 periods and to identify the long run trends. Additionally the efficacy was examined of reorienting the program during 1966-67 by making it target-oriented and time-bound. Data from the Year Book on the Family Welfare Program pertaining to expenditure performance and impact were used. These data were available from the financial year 1966-67 onwards. Prior to this there were 2 limitations to the available data: the data on performance of various family planning methods and their impact on couple protection births averted and so forth had been given in the form of calendar years from 1956-66. Consequently the performance data given by Bali Ram in regard to sterilization and IUDs for the years 1956-57 to 1965-66 were used. Secondly the performance data on conventional contraceptives were available in aggregated form for 3 years (1963-65). These were split into 3 financial years i.e. 1963-64 1964-65 and 1965-66 on the basis of the proportions of sterilizations during these individual years. 3 measures were used in the analysis: cost per equivalent sterilization; cost per couple protected; and cost per birth averted. Considerable fluctuations were evident in respect to the number of equivalent sterilizations especially between 1968-69 and 1977-78. Some of the variations in the output were directly related to the level of the program expenditure especially between 1972-73 and 1982-83. Program expenditure and the output in terms of equivalent sterilization were strongly correlated supporting the view that the output of the family planning program varies with variations in program expenditure. The MC and AC curves in regard to equivalent sterilizations showed sections of AC curves with MC curves intersecting them at lowest points around 1959-60 and 1967-68. The longterm AC curve seemed to be a shallow U-shaped curve. The cost curves relating to the couple-years effectively protected also showed a similar trend. The cost curves relating to cost per birth averted showed rather different patterns of the long run AC and MC both decreasing over time with the AC decreasing relatively steadily to an apparent minimum in 1979-80. This measure showed less sensitivity to short term changes. The results of the means test of AC of equivalent sterilizations before and after 1966-67 suggest that this measure has been increasingly cost effective.

Short- and long-run marginal cost pricing: On their alleged equivalence

The equivalence between short-run marginal cost (SRMC) and long-run marginal cost (LRMC) in a fully adjusted equilibrium has been proved over and over again. In the literature dealing with public utility pricing, this basic result has been taken to imply that it is optimal to set prices at LRMC. Important contributions to this literature are reviewed in this paper. The equivalence, however, is valid only under the very restrictive assumption that the capacity can be varied continuously. This means that indivisibilities, irreversibilities and durability of investments are ignored. Where such phenomena exist, as in electricity production and distribution, pricing according to LRMC is neither theoretically valid nor applicable. It is not surprising that it has been difficult for public utilities to define the LRMC concept operationally; average cost concepts are used as ‘approximations’. Under these circumstances we find it advisable to dispense with the LRMC concept altogether and rely on pricing based on SRMC.

Energy Economics, Demand Management and Conservation Policy

In the first half of their book, the authors identify the demand factor within the overall view of the energy economy, widen the field of investigation to take in the other major links in the energy chain represented by reserves and production facilities, and analyze demand within the framework of overall energy policy. They stress that pricing policy is the main instrument of demand management, then proceed to explain how long-run marginal cost is the practical pricing basis and how energy-saving measures are the most logical way to check any rise in consumption. They then highlight the close interrelationship between supply and demand. The second part of the book presents case histories on Sri Lanka, Thailand, Bangladesh, the US, Costa Rica, and Brazil. 500 references, 62 figures, 109 tables.

Dumping, adjustment costs and uncertainty

Domestic demand uncertainty in the presence of adjustment costs can cause profit-maximizing firms to sell output abroad at a loss. Firms may dump output at prices below long-run marginal and average productions costs with probability arbitrarily close to one. The model predicts dumping is particularly likely in process industries such as steel. Closed form dumping solutions and interesting comparative statics are obtained. Also, the effect of domestic competition on dumping is examined. I find domestic competition increases total dumping, although a monopolist maximizing output subject to a zero expected profit constraint will dump more than a competitive industry.

Uncertainty in hydroelectric power supply

This paper discusses the dimensioning and capacity utilization of a hydroelectric power system when uncertainty in supply and demand is taken explicity into consideration. It is shown how the optimal sales of firm power depend on properties of the long-term and short-term demand curves. A long-run marginal cost criterion is derived, which shows that the long-run marginal cost should be equal to the expected price in the short-term market. Uncertainties in supply as well as demand will, under reasonable assumptions, reinforce each other with respect to their implications for the excess capacity in the hydro power system.

Offshore Exploration Performance and Industry Change: The Case of the Gulf of Mexico

Summary This paper considers industry structure and the exploration performance (by size class of operator) of firms searching for oil and gas in the U.S. Gulf of Mexico. It also tracks the changes in industry structure that have occurred in response to a decline in the quality of remaining prospects in the area. Data presented indicate that because vertically integrated majors dominated in exploration in the early years of the Gulf of Mexico exploration history, they were able to discover 86% of the total hydrocarbons discovered through 1975. However, the data also show a dynamic relationship between the structure of the industry operating in an area and the quality of remaining prospects. The relative share of both credited discoveries and wildcat wells of nonmajor operators has increased as exploration in the gulf proceeded. For example, in state-owned waters from 1951 to 1955, major inns accounted for 85% of all wildcat wells drilled, whereas from 1971 to 1975 these firms accounted for only 30% of the wildcat wells. During these same two periods in the federal Gulf of Mexico, the majors' share of wildcats fell from 98% to 70%. Introduction U.S. crude-oil production in the conterminous 48 states peaked in 1970 and the production of natural gas attained its maximum in 1973. At the time, few were concerned with the consequences of the nation's growing dependence on imported oil. The supply disruptions of the 1970's helped focus attention on the structure of the domestic oil industry. Critics of the industry have charged the major integrated firms with restricting domestic oil and gas production by not concentrating their exploration efforts in the conterminous U.S. In addition, industry critics have been concerned with the wave of recent mergers and the possible anticompetitive effects of a concentration of domestic reserves. Because 80 to 90% of the wildcat wells drilled in the U.S. are usually drilled by independent operators, some critics have reasoned that the divestiture of the exploration and production units of the large integrated firms into regional units would increase domestic exploratory drilling and thereby increase supply. Other suggestions to increase the role of small firms in federal Outer Continental Shelf (OCS) development have already been implemented by permitting royalty bidding for selected tracts and prohibiting joint bidding by the larger firms. Several studies already have been performed in which financial rates of return (ROR) were compared across industries and across groups of firms (classified by size) that operated in the Gulf of Mexico. These studies have neglected physical measures of firm performance and the dynamic trends in the discovery process. This paper presents data on firm exploration performance and addresses petroleum industry changes that have occurred in the Gulf of Mexico. Analysis of these data shows a relationship between the nature or structure of the industry operating in an area and the quality of remaining prospects. This paper reviews past studies that compare returns to offshore operation by firm size. Then, the exploration performance of various size classes of firms operating in the Gulf of Mexico is discussed, as are changes in the structure of the petroleum firms operating there. In the concluding section the implications of the data are considered. Previous Industry Studies Economists often examine an industry's structure and reported earnings on equity to predict its performance in terms of economic efficiency. A study by R. Shriver Assocs. indicates that overall concentration (dominance of the industry by the top few firms) of the petroleum industry does not significantly exceed that of many U.S. manufacturing industries. It is frequently argued that, if firms are monopolizing an industry, long-run marginal costs will depart substantially from price and that earnings will be greater than the returns in competitive industries. Erickson and Spann showed that the overall profit rates for the eight largest petroleum firms were similar to rates reported by U.S. manufacturing firms. These studies consider all stages of the petroleum industry and do not focus on exploration behavior or performance. In one of the earliest studies of competitive conditions in the search for oil and gas, McKie concluded that competition was effective because there were no substantial artificial barriers to exploration in most areas for independent firms. McKie also pointed out that the independents' symbiotic relationship with the majors in joint or cooperative ventures worked to the advantage of both industry sectors.

Joint Costs and Intra-Tariff Cross-Subsidies: The Case of Liner Shipping

THE problem of allocating joint costs arises in attempts to analyse the profitmaximising behaviour of multiple-product firms. If the production occurs in technically fixed proportions, so that an increase in the output of any one product always entails an increase in the output of all other products,1 then it is invalid to attempt to separate costs in a manner which assumes away the indivisibilities.2 In such circumstances it is therefore not possible to determine unambiguously the marginal cost of the separate products, and any attempt to use such estimates to represent normative prices, is untenable as an objective statement.3 Thejoint cost problem is less pressing in the perfectly competitive case as the long-run equilibrium requires that the marginal cost of producing the joint bundle is equal to the price at which the marginal unit of the joint bundle is sold, and the relative prices of the outputs contained in the bundle can be determined from the respective demand functions. If, however, the firm is not operating in a perfectly competitive environment, then the possibility of price discrimination between different buyers of any one product cannot be dismissed, and if it does exist, monopoly power cannot be measured in terms of the relationship between long-run marginal cost and prices when the firm's outputs are joint products. Similarly, a further segmentation of the market according to common products,4 with the prices of some products in excess of their separable costs, will not necessarily reveal the extent of monopoly profit. If the firm charges different prices for different products5 only to the point of allocating fully the joint costs, with gross revenue exactly equal to the minimum return required for sustained operation in the long run, then the firm's prices can be considered to be equivalent to the perfectly competitive

Cogeneration — allocation of joint costs

In planning district heating projects based on cogeneration, a rule is required to split the simultaneous costs over electricity and heat. This article formally structures the discussion on this issue, and an allocation rule, using the long-run marginal generation costs of the byproduct, is argued to be the best one from a district heating planning viewpoint.

The Economics of Western Coal Severance Taxes

The recent upheavals in fuel markets have altered competitive relationships between fuels. Rising prices and government regulations have eliminated oil and gas from consideration as fuels for new electric utility plants. Further, public acceptance of nuclear power has diminished to the point that coal is the only practical alternative source of energy for new base-load generation facilities. This change in market structure creates opportunities for those with market power. The demand for coal has become less elastic, and those in a position to exert market power can take advantage of the situation to raise prices. The coal industry itself is competitive. Coal producers will, in the long run, be forced to sell at long-run marginal cost where marginal cost reflects the cost of production as well as the competitive rent accruing to owners of depletable resources. Labor supply is, to an extent, controlled by the United Mine Workers union, yet competition from nonunion miners limits the union's ability to act.1 Other elements of the inIncreases in oil and gas prices and the decline of nuclear power have led to an increase in the competitiveness of coal. This change in relative economics has been particularly great for the six western coalproducing states where large low-cost deposits of environmentally acceptable low-sulfur coal are found. Montana and Wyoming have responded to this situation by raising severance taxes substantially, and other states are considering similar actions. This has led to congressional attempts to limit state coal taxes. Using an integrated model of the U.S. coal and electric utility industries, this paper estimates how high coal severance taxes might rise with and without such legislation. Competition and incentives for cooperation between Montana, Wyoming, and other western states are examined. Efficiency and distributional implications are discussed. * An earlier and much different version of this paper was issued as Hoover Institution Working Paper E80-9. We are indebted to George Rozanski and Carol Bugbee for help in implementing the model described herein and to an anonymous referee for helpful suggestions. We are also indebted to the M.I.T. Center for Energy Policy Research for the support that allowed us to complete this revised version and to the Hoover Institution for its initial support. 1. Western coal production has expanded most rapidly and miners there are largely nonunion.

The marginal cost of solar backup

The long-run marginal cost of providing electricity for solar heating and hot water systems is estimated for three utilities and compared with the cost of providing electricity to electric-only systems. All investment, fuel, and operating costs are accounted for. Hot water systems and combined heating and hot water systems are analyzed separately. It is found that the marginal cost for solar backup is no more than the marginal cost of electricity used for purely electric heating and hot water devices and also no more than the incremental cost of normal load growth. For the three utilities studied, there appears to be little basis for rate distinctions between solar devices using electric backup and electric-only heating and hot water devices. “Off-peak storage” heating and hot water devices have a much lower marginal cost than the standard systems; again, there appears to be no basis for distinguishing between solar and electric off-peak devices. Compared with average cost pricing, marginal cost pricing offers benefits to customers using solar and electric heat and hot water, especially if a separate lower rate is adopted for off-peak storage devices; these benefits can amount to several hundred dollars a year. Substantial savings in the use of oil and gas fuels can be achieved if residences using these fuels convert to solar systems, savings not necessarily achievable by a shift, instead, to electric systems.

Electricity Pricing; a Comprehensive Framework

This paper presents a framework for electric power pricing, reviews the basic theory of marginal cost pricing applicable to the power sector, and summarizes recent developments in the area. The adaptation of the theory for practical application in relation to the objectives of power pricing policy results in a two stage procedure for tariff setting. First, the strict long-run marginal costs (LRMC) of supply which meet the economic efficiency criterion are computed. Second, the strict LRMC is adjusted to arrive at an appropriate realistic tariff structure which satisfies various constraints, including economic-second best and social-lifeline rate considerations, financial Viability, and simplicity of metering and billing.

Principles of modern electricity pricing

This paper presents a framework for electric power pricing, reviews the basic theory of marginal cost pricing applicable to the power sector, and summarizes recent developments. The adaptation of the theory for practical application in relation to the objectives of power pricing policy results in a two stage procedure for tariff setting. First, the detailed structure of the strict long-run marginal costs (LRMC) of supply which meet the economic efficiency criterion are computed. Second, the strict LRMC is adjusted to arrive at an appropriate realistic tariff schedule which satisfies other constraints, including economic second best and social lifeline rate considerations, financial needs, simplicity of metering and billing, etc. The results obtained through past applications of modern pricing structures internationally are reviewed, and the U.S. situation is discussed with respect to the Public Utility Regulatory Policies Act (PURPA) of 1978.

Long-run costs in uranium production

Long-run marginal production costs for uranium oxide are estimated. The estimates are derived from reported costs for the individual components of cost to the firm: exploration costs, capital costs of mining and milling facilities, variable costs of mining, hauling and milling, and taxes, royalties and normal return to invested capital. Spot prices in mid-1977, having increased sevenfold over the previous five years, were at the high end of the range of cost estimates for what was considered likely to be a marginal production facility. Thus, it was considered unlikely that market prices would continue to increase significantly. In fact, recent prices indicate a decline in real terms has occurred.

Modeling Depletion in a Mineral Industry: The Case of Coal

This paper has a two-fold purpose. The wider and more abstract purpose is estimating the long-run marginal cost of producing a depletable resource. The second purpose is the illumination of several important policy issues dealing with the development of coal resources. The essence of depletion is the movement from cheaper to more costly deposits. Econometric models estimated from past observations on prices and outputs cannot capture this movement, since the past reflects only the more favorable deposits.

Entry Barriers and the Growth of Firms

Among firms beyond a minimum efficient size, rate of growth is generally unrelated to firm size [4; 5; 10; 21]. Nevertheless, stochastic models that assume firm size and rate of growth are completely unrelated have had only limited success in predicting the size distribution of firms [15]. So perhaps in special circumstances firm size can affect growth. Our purpose is to identify growth incentives that can plausibly be argued to exist only when barriers to entry are very high, and then test for the effect of these incentives by contrasting samples of firms operating under different entry conditions. Our results indicate that firm size can affect rate of growth more when new entry is barred. In examining capacity expansion incentives for the firm in an industry when entry is barred we assume homogeneous product, and we assume that price competition is ineffective due to some form of price leadership, or to tacit cooperation at an entry preventing price [1; 11; 25]. We also assume Cournot-like capacity adjustment behavior on the part of individuals firms. We find on these assumptions that relative size and technology influence expansion incentives when entry is barred. In particular, a firm may independently refrain from expansion even though price is above long-run marginal cost. On specifying the model and estimating its parameters, we find differences between parameter estimates for 21 firms in industries with very high entry

Some problems of estimating the long-run marginal costs of electricity A vintage capital approach

There exists a considerable body of literature on the applicability of the marginal cost principle to electricity pricing and in particular on the distinction between peak and off-peak pricing. However, if we try to derive numerical estimates for the marginal cost of peak electricity, practical problems arise that do not yet appear to have received adequate attention. One such problem is the existence of technical progress, leading to steady decline both in investment costs and in running costs. Another is the possibility of divergence between social and private costs, e.g. in India the social cost of low-grade coal is lower than its private cost while for foreign exchange the reverse appears to be true. The purpose of this paper is to derive an estimate for the peak charge appropriate for a purely thermal system in India, which takes some of these problems into account. The paper has three sections. A theoretical approach is developed in Section I. Numerical estimates based on this approach are calculated in Section II. Some generalisations are suggested in Section III.

C. E. G. B.'s Bulk-Supply Tariff and Long-Run Marginal Cost

C. E. G. B.'s Bulk-Supply Tariff and Long-Run Marginal Cost

Oil Prices in the Long Run (1963-75)

EVERY attempt to predict oil prices is certain to result in mistakes. But if we can analyze the elements of the problem one by one before fitting them together, we can learn much. Moreover, the degree of ignorance is not the same in every part of the analysis. Even if we are incapable of correctly foreseeing the whole picture, we can at least establish some partial truths which could in turn help government officials, business management, etc. Application of economic theory to issues in petroleum pricing that involve short-run and longrun marginal cost should contribute to better understanding of both concepts and issues. And many of the questions require dialogue and even co-operation between economists and engineers. most urgent task is to bring to light the chief influences that bear on oil prices today and tomorrow in order that experts can utilize these materials for reflection and research. This paper is intended to stimulate such debate. L'Etude sur les perspectives tenergetiques de la CommunauMt europ6enne, published at Luxembourg in December, 1962, by the intercommunity working party, has defined the problem: the prices at which oil can be supplied from the present to 1975. Despite any doubts of their conclusions, one must be deeply grateful to the authors of this study, for they have been able to pose the problem as a consistent, coherent whole; it is hardly too much to say that they have demystifled it. We propose to study the problem in four stages: (1) the structure of real, not posted, prices today; we need to ask if such a structure even exists.' (2) Setting aside, for the moment, the price of crude oil, can this structure maintain itself over the long run, or does it contain distortions or inconsistencies which will make it change in the near future? (3) What developments are expected to influence the costs (aside from the price of crude) and hence the prices of refined products? (4) What forces bear on the price of crude * This article is a slightly revised translation of an article published in French in the December, 1963, issue of the Revue de l'Institut Francais du Petrole, and appears here with permission. It is part of a project of research on the world oil market since 1945, supported by Resources for the Future, Washington, D.C. See my essay, The World Oil Outlook, in Natural Resources and International Development, ed. Marion Clawson (Baltimore: Johns Hopkins Press, 1964), for a treatment of the theories and methods used here. I wish to thank the Institut Frangais du P6trole, especially Mme Jacqueline Funck and M. Jean Chappelle, for their kind hospitality. It is both a pleasure and a duty to acknowledge the suggestions, criticisms, and discussion of J. Barnea, M. Boudard, G. Brondel, L. Bruni, B. Corradini, J. Curry, R. Deam, S. Friis, C. Grigg, H. Gripaios, J. Hartmann, J. Hartshorn, V. Henny, J. Jorgensen, L. Kaplan, P. Maillet, W. Newby, G. Parisot, F. Parra, D. Ovens, J. Ritchie, W. Stewart, and P. Wack. These persons bear no responsibility for any errors or opinions whatever.

An Application of Marginal Cost Pricing: The `Green Tariff' in Theory and Practice

From the analysis in Part I,1 certain practical conclusions of a general character may immediately be drawn. First and foremost, the analysis implies that rates should be fixed, so far as possible, in accordance with time of consumption-i.e. that some sort of timeof-day (and time-of-year) tariff should be introduced. Second, it implies that one should 'charge high rates at times when consumption would tend to rise above the level of capacity, so as to bring the corresponding portion of the load curve down to the horizontal'. And third, it implies that one should charge low rates at times when 'consumption at the price fixed cannot attain the level of capacity'with the important proviso here that the rates charged should never be lower than short-run marginal costs. As a result of this pricing policy, it is suggested, the load curve would become horizontal, with hollows here and there in places where a price equal to short-run marginal cost was still not low enough to extend demand to the level of capacity.2 The great question, however, is that of how far one should in fact go in making the load curve horizontal. By increasing prices and reducing capacity sufficiently, the load curve could if required be made completely horizontal, with no hollows in it at all; but this would usually mean lowering it far below the level which most people would consider desirable. It is in relation to this crucial question of the appropriate level of the horizontal portion of the load curve that Boiteux makes what is perhaps his most useful and distinctive contribution. The level of the horizontal part of the curve which should properly be aimed at, he argues in effect, is determined by the condition that the prices charged to the demand or demands on the horizontal part of the curve should be just sufficient to cover not only the appropriate energy costs but also the whole of the long-run marginal capacity cost. And this condition will automatically be fulfilled, as we have seen, if the capacity of the plant is adjusted to the 'optimum' level. In the 'optimum' situation, the pursuance of

New Developments on the Oligopoly Front: Cournot and the Bain-Sylos Analysis

THE recent review article by Franco Modigliani on books by Sylos Labini and Bain2 reports on new and interesting work on the empirical and theoretical consequences for the study of oligopoly of considerations of entry and potential competition. The theoretical model he presents, however, may at first glance cause a feeling of deId vu, since the behavior assumed in it seems at least reminiscent of Cournot. I discuss this question here primarily with reference to the way in which the results of the BainSylos model as presented by Modigliani compare with the results of a Cournot model enlarged to take account of entry. I do not discuss the question whether the behavior assumed in one model can be considered more realistic than assumed in the other or, indeed, the question whether either behavioral assumption can be considered plausible. For convenience, I restrict my attention to what may be termed the pure case of the Bain-Sylos model. Here the product is homogeneous and, for each firm (potential entrants included), long-run average cost is assumed to be perfectly constant for output greater than, or equal to, a certain minimum optimal size, x, and prohibitive for output below size. The level of long-run average (equals long-run marginal) cost for outputs greater than or equal to x is k. In perfect competition,3 equilibrium price would be k and total industry output Xc, output for which the demand and marginal-cost curves intersect. Modigliani defines the size of the market, S, as the ratio of competitive output to minimum optimal size: S = Xc/x. In the model presented by Modigliani, a Sylos' postulate is made: that potential entrants behave as though they expected existing firms to adopt the most unfavorable to them, namely, the of maintaining output while reducing the price (or accepting reductions) to the extent required to enforce such an output policy (p. 217). On this assumption, it follows immediately the smallest entry-blocking industry output, X0, is