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An Application of the Expenditure Function in Electricity Pricing: Optimal Residential Time-of-Use Rate Option

Caves et al. (1983) recently reported that mandatory time-of-use (TOU) pricing for residential customers served by four Illinois electric utilities fails to pass the cost-benefit test. Gains in economic efficiency are outweighed by the relatively high TOU meter costs. An obvious alternative is to offer a TOU rate option for which customer participation is voluntary (see, for example, Woo et al. [1983, Section D] and Malko and Faruqui [1980, pp. 161-62]). The problem of optimal pricing under self-selection has been analyzed by Faulhaber and Panzar (1977), Panzar and Sibley (1978), and Mirman and Sibley (1980). Following these studies, this paper derives the optimal electricity prices when a customer can choose between paying the TOU rates and the full incremental costs of a TOU meter and remaining on a flat rate schedule. My approach departs from the earlier studies in using the expenditure function to characterize the optimization problem as described by Diamond and McFadden (1974).

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Energy Specializations: Energy Modeling – Other; Electricity – Markets and Prices

JEL Codes: L11: Production, Pricing, and Market Structure; Size Distribution of Firms, Q42: Alternative Energy Sources, Q41: Energy: Demand and Supply; Prices, D40: Market Structure, Pricing, and Design: General, D47: Market Design

Keywords: Electric utilities, TOU pricing, Illinois, Residential electricity demand

DOI: 10.5547/ISSN0195-6574-EJ-Vol6-No2-7

Published in Volume 6, Number 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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