Natural Resource Economics

ECN 317

Assignment 7

Due Date: 11/09/2017

Total points: 30

1. Below is the information for the electric power system for the state of Utopia. The generating capacity for the state is owned by a competitive industry.

1. Suppose the state public utility commission of Utopia decides to regulate the prices the industry can charge using the following rule: average cost of generation plus $0.07/Kwh for transmission and distribution costs. What will be the retail price under this scheme of regulation if the demand is 3500 Mwh and if the demand is 7500 Mwh.

If the demand is 3500 Mwh: TC = (400 x 4) + (1600 x 8) + (500 x 35) = 31,900

                                       AC = (31,900)/3,500 = 9.11 + 70 = 79.11 Mwh

If the demand is 7500 Mwh: TC = (400 x 4) + (1600 x 8) + (3000 x 35) + (1000 x 45)         

                                + (1000 x 65) = 229,400

                                AC = (229,400)/7,500 = 30.60 + 70 = 100.6 Mwh

1. What can you say about the economic efficiency of the above stated pricing scheme?

The above stated pricing scheme is economically efficient because it is optimally allocated to serve each entity in the best way while minimizing inefficiency.

1. If we assume that the utility commission requires the industry to charge the customers the wholesale price of electricity (assuming that the wholesale industry is a competitive industry) plus the same transmission and distribution costs as part (a). What is the price for the same demand scenarios mentioned in part (a)?

If the demand is 3500 Mwh: 35 + 70 = 105 Mwh

If the demand is 7500 Mwh: 65 + 70 = 135 Mwh

1. What can you say about the economic efficiency of the above stated pricing scheme?

The above stated pricing scheme is not economically efficient because it is not optimally allocated to serve each entity in the best way while minimizing inefficiency.

1. Edison Electric is an IOU with its own transmission and distribution facilities along with a generation capacity of 15 million Mwh each year. Its rate base is $12 billion and annual total expenses are $350 million. The allowed rate of return on the rate base by the state public utility commission is 10 percent.

1. What is the price of electricity sold by Edison and its annual earnings?

                Annual Earnings = 1,200 x 10% = 120 million

                Price of Electricity = (3,500 + 120)/1,500 = $2.41 Mwh

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