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Price Discrimination Limits in Relation to the Death Spiral

It is well known that a public utility commission may be able to improve overall social welfare by allowing decreasing-cost industries (such as local public utilities) to price discriminate. For this course of action to be practical, the following conditions must prevail: (1) marginal-cost prices do not cover costs and (2) external subsidies are not feasible. Consequently, the need to raise prices above marginal costs means that some social welfare, measured as the sum of consumer's and producer's surplus, for example, must be sacrificed to allow the utility to break even. To minimize this sacrifice, the proportional deviation of price from marginal cost for each service should be correspondingly larger for markets with inelastic demands than for those in which demand is elastic.' This type of inverse elasticity rule seldom is used in practice and is cited here only to illustrate that pure value-of-service pricing may improve overall social welfare.

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Energy Specializations: Energy Modeling – Other

JEL Codes: D42: Market Structure, Pricing, and Design: Monopoly, D40: Market Structure, Pricing, and Design: General, L95: Gas Utilities; Pipelines; Water Utilities, L11: Production, Pricing, and Market Structure; Size Distribution of Firms, L94: Electric Utilities, Q41: Energy: Demand and Supply; Prices

Keywords: Public utilities, price discrimination, Death spiral, social welfare

DOI: 10.5547/ISSN0195-6574-EJ-Vol7-No3-3

Published in Volume 7, Number 3 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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