Electricity Marginal Cost Pricing

Electricity Marginal Cost Pricing

Applications in Eliciting Demand Responses

1st Edition - February 2, 2012

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  • Author: Monica Greer
  • eBook ISBN: 9780123854667
  • Hardcover ISBN: 9780123851345

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Packed with case studies and practical real-world examples, Electricity Marginal Cost Pricing Principles allows regulators, engineers and energy economists to choose the pricing model that best fits their individual market. Written by an author with 13 years of practical experience, the book begins with a clear and rigorous explanation of the theory of efficient pricing and how it impacts investor-owned, publicly-owned, and cooperatively-owned utilities using tried and true methods such as multiple-output, functional form, and multiproduct cost models. The author then moves on to include self-contained chapters on applying estimating cost models, including a cubic cost specification and policy implications while supplying actual data and examples to allow regulators, energy economists, and engineers to get a feel for the methods with which efficient prices are derived in today’s challenging electricity market.

Key Features

  • A guide to cost issues surrounding the generation, transmission, and distribution of electricity
  • Clearly explains cost models which can yield the marginal cost of supplying electricity to end-users
  • Real-world examples that are practical, meaningful, and easy to understand
  • Explans the policy implications of each example
  • Provide suggestions to aid in the formation of the optimal market price


Power Engineers, Electrical Engineers, Energy Engineers, Energy Economist, Environmental Engineers, Mechanical Engineers, and Industrial Engineers

Table of Contents

  • Preface

    1. Introduction
    Competitive Paradigm
    Marginal Cost Pricing Doctrine
    A Brief Overview of the United States Electric Market
    Objective Functions: The Players
    Reducing Carbon Emissions
    Regulation of Investor-Owned Electric Utilities in the United States
    Internalizing the Cost of Reducing Carbon Emissions
    Optimal Rate/Tariff Design and Tax Credits to Promote Efficient Use of Energy and a Reduction in Carbon Emissions
    Tariff Design and Rate-Making Issues

    2. The Theory of Natural Monopoly and Literature Review
    The Natural Monopoly Conundrum
    Defining Natural Monopoly
    Economies of Scale
    Efficient Industry Structure

    3. U.S. Electric Markets, Structure, and Regulations
    The U.S. Electric Industry Structure
    Market Participants
    Vertically Integrated Model
    Industry Restructuring and the Competitive Electric Market
    Regulation of the Electric Utility Industry
    Looking Forward: Renewable Resources and Generating Technologies
    Future of the Electric Industry

    4. The Economics (and Econometrics) of Cost Modeling
    General Cost Model
    The Econometrics of Cost Modeling: An Overview
    A Brief History of Cost Models and Applications to the Electric Industry

    5. Cost Models
    Determination of an Appropriate Objective Function: A Brief Overview of the Literature
    Rural Electric Cooperatives
    Differences between Coops and IOUs
    Literature Review: Cost Studies on Rural Electric Cooperatives
    Review of the Literature: Cost Function Estimation in the Electric Utility Industry
    Nerlove’s Cobb–Douglas Cost Model
    Further Considerations
    End of Section Exercises: Basic Cost Model versus Nerlove Cost Model
    Flexible Functional Forms
    Translogarithmic Cost Function
    Cost-Share Equations
    A Priori Expectations
    Discussion of Estimation Results: Single-Output Translog Cost Equation
    Substitution Elasticities among Inputs: Hicks–Allen Partial Elasticities of Substitution
    Price Elasticities
    End of Section Exercises: Translogarithmic Cost Function
    Multiproduct Cost Functions
    Literature Review
    Multiproduct Cost Models
    Multiproduct Cost Concepts (Revisited)
    Product-Specific Economies of Scale
    Quadratic Cost Functions
    A Properly Specified Quadratic Cost Function
    Reasons That the Quadratic Form Is the “Best” Suited for Modeling Industry Structure
    End of Section Exercises
    Cubic Cost Models
    Multiple-Output Models
    More Complex Multiple-Output Models
    Other Issues
    Measures of Efficiency for Multiple-Output Models
    Ray Cost Output Elasticity
    Degree-of-Scale Economies
    Product-Specific Economies of Scale
    Economies of Scope
    Cost Complementarity
    End of Section Exercises: Multiple-Output Cost Models
    Appendix: Generalized Method of Moments (GMM)
    Appendix: Proofs

    6. Case Study
    Theory of Efficient Pricing
    Study Design
    Reasons that Cooperatively-Owned Utilities Are Different
    Literature Review
    Estimating Cost Models
    Cost Models
    Estimation Results
    Efficiency Measures
    Discussion of Figure 6.4—Average Incremental Cost and Marginal Cost
    General Implications of Estimation Results
    Appendix A: Panel Data
    Appendix B: Heteroscedasticity-Consistent Covariance Matrix Estimation

    7. Case Study
    Cobb–Douglas Cost Model
    Elasticities of Substitution for Cobb–Douglas
    Translogarithmic Cost Function
    Substitution Elasticities for the Translog Form: Hicks–Allen Partial Elasticities of Substitution
    Price Elasticities
    Generalized Leontief Cost Function
    Empirical Estimation
    Iterated Zellner-Efficient Estimator
    Generalized Leontief Cost Function—Elasticities
    Quadratic Cost Model
    Nonlinear Quadratic Cost Model
    Morishima Elasticities of Substitution
    Appendix: Quasiconcavity in Input Prices

    8. Efficient Pricing of Electricity
    Theory Of Efficient Prices
    Debate on the Optimal Pricing of Electricity: A Brief History
    Rate Design
    More About Rate Design: In Theory
    Overview of Rate Design Process
    Efficient Public Utility Pricing
    Ramsey Prices: A Second-Best Option4
    Ramsey Pricing—The Second-Best Option
    Another Option: Average Cost Pricing
    Two-Part Tariffs
    Two-Part Tariff with Different Customer Classes
    Multipart Tariffs
    Nonuniform Pricing: Block Rates
    Time-of-use Rates
    A Brief History of Time-Of-Use Pricing
    Real-Time Pricing
    Understanding Electric Utility Customers
    Assessment of Rate Structure Options

    9. Price and Substitution Elasticities of Demand: How Are They Used and What Do They Measure?
    Price Elasticity of Demand
    A Brief Review of the Literature: Energy Demand, Elasticities Of Demand In Energy Markets, And Functional Forms
    Price And Substitution Elasticities
    Dynamic Models
    Structural Models
    Expenditure System Models
    Econometric Issues: Identification and Systems Bias
    Simultaneous Equations
    Consistent Parameter Estimation
    More Advanced Estimation Methods
    Additional Econometric Issues (Berndt, 1991)
    A Brief Survey of the Literature: Price Elasticity of Demand
    Substitution Elasticities
    Federal Legislation
    Technology—the “Smart Grid”—How It Works
    More Complex Models: Price And Substitution Elasticities Using Constant Elasticity of Substitution Model
    Overview of Results—Faruqui And Sergici Study
    For Interested Readers
    Recommended Reading

    10. Time-of-Use Case Study
    The Electricity Crisis: Summer 2000
    Chapter Overview
    Literature Review
    Effect of Time-Of-Use Pricing On Peak Utility Load
    Recent Experience in California
    The California Debacle: A Decade Later
    Using Real-Time Pricing to Estimate Price Elasticity of Demand
    Further Implications of the Residential Responsive Pricing Pilot
    Peak-Load Pricing
    Substitution Elasticities
    Elasticities of Substitution

    Recommended Reading

Product details

  • No. of pages: 366
  • Language: English
  • Copyright: © Butterworth-Heinemann 2012
  • Published: February 2, 2012
  • Imprint: Butterworth-Heinemann
  • eBook ISBN: 9780123854667
  • Hardcover ISBN: 9780123851345

About the Author

Monica Greer

Monica Greer is a Senior Quantitative Analyst based in Kentucky, United States. Her role includes forecasting market shares for appliances, performing analysis and deriving price elasticities for clients. Previously, she was a Senior Business Consultant and Economist, and a Senior Economist for the Louisville Gas and Electric Company, managing impacts of various carbon-related policies on customer demand and performed load research and analysis. Monica is also currently an Adjunct Faculty member of the Department of Economics at Bellarmine University in Kentucky and taught previously at Jefferson Community College, University of Kentucky, and Indiana University. Monica earned a PhD in economics from the University of Kentucky, an MA in economics from Indiana University, and a BBA in finance from the University of Kentucky. She was awarded into the University of Kentucky Honors Program, has published two books, both with Elsevier, and has published several journal articles and provided presentations.

Affiliations and Expertise

Senior Quantitative Analyst, Kentucky, USA

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