THE IMPACT OF REGULATION ON ELECTRIC UTILITY PRICING: AN ECONOMETRIC TEST OF RAMSEY PRICING

Several studies (Meyer and Leland, 1980, and Nelson, 1982) test the hypothesis that pricing in the electric utility corresponds to Ramsey pricing. Information obtained from these tests can be used to examine whether or not electric utility regulation has been effective in promoting the efficient use of economic resources in that industry.;The present study develops an econometric model to test several hypotheses pertaining to the rate structure of the electric utility industry. The marginal cost estimates used in this model allow us to consider explicitly the joint nature of the cost of producing electricity for different user groups, and the Ramsey number is modeled to capture various details of the rate-setting procedures. The model is used to estimate a set of Ramsey optimal prices and the pattern of inefficiency in the rate structures, and to calculate the potential welfare gains from more efficient regulation. The model estimates also provide a simple, direct test of the hypothesis that there is optimal second-best or Ramsey pricing, marginal cost pricing, or monopolistic pricing in the electric utility industry.;The empirical results indicate that regulation has failed to achieve efficiency in pricing. On average, in 1970 residential and commercial users were being subsidized by industrial customers, while in 1978 residential customers were being subsidized by the other two groups. The results also indicate that an increase in the size of a customer class increases the price that class has to pay relative to the cost of serving that class. The efficiency losses associated with current rate structures set by regulatory agencies are estimated to be substantial.;The last part of this study is an attempt to determine whether the pattern of inefficiencies present in the electric utility rate structure is systematically affected by differences in regulatory environments. The empirical results indicate that the inefficiencies can be explained in part by differences in regulatory environments.;These studies, however, have several shortcomings. First, marginal cost is assumed to be constant or a function of just one output. Second, Ramsey numbers are constructed rather than estimated together with marginal cost. These shortcomings will be corrected in this study.