8 - Non-Linear Pricing in Regulation

Summary

The average price is essentially set to ensure a fair rate of return to the regulated firm, but it is also the weighted average of the various prices faced by the various types of users. Which specific prices and which specific weight the average price reflects depends on the forms of price discrimination and price differentiation adopted by the firm. Full price discrimination is unrealistic under current consumption measurement technologies and political constraints. Most firms providing public services rely on second- and third-degree price discrimination or some combination of the two. From a regulated firm’s perspective, price discrimination is an effective way of maximizing its share of the surplus produced by its activities. From a social welfare perspective, price discrimination can have both positive and negative effects as it can improve or worsen both efficiency and equity: the net effect depends on the specific market analysed and the specific form of price discrimination adopted by the firm. Rapid improvements in the technologies available to measure consumption such as smart meters imply that firms can implement increasingly precise forms of price discrimination.