On measuring the gain in economic welfare from marginal cost pricing when a related market is of importance: the case of electricity and natural gas

by Stanley Besen, Bridger M. Mitchell

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Argues that an analysis of the welfare effects of electricity rate reform cannot be limited to the market for electricity alone. At a minimum the analysis must be expanded to include the market for natural gas. Consequently, in addition to observing demand functions for electricity, and the marginal cost function of supplying electricity, one must specify both the demand curves for natural gas (including the demand by electricity producers) and the marginal cost curve of supplying gas, in order to correctly analyze the effects of a change in electricity rates. Applying welfare analysis to the policy of electricity rate reform requires the use of general equilibrium models of the energy sector which incorporate demand and supply interactions between different fuels. Adapting existing models and developing new ones can contribute to evaluation of energy policy alternatives.

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