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Utility Regulation and Risk Allocation: The Roles of Marginal Cost Pricing and Futures Markets

  • Simon GB Cowan
  • Simon Cowan

The paper assesses the welfare effects of different ways of allocating input price risk between a regulated utility, consumers and speculators in a futures market. A risk-averse utility setting a fixed retail price requires a price that exceeds expected marginal cost, unless an efficient futures market is available. The firm bears no risk when input price risk is transferred to consumers, but consumers may not like price risk. When a futures market is available to consumers marginal cost pricing is always preferable to a fixed retail price. The policy conclusion is that marginal cost pricing should be combined with the development of futures markets in which consumers can hedge.

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File URL: http://www.economics.ox.ac.uk/materials/working_papers/paper100.pdf
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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 100.

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Date of creation: 01 Mar 2002
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Handle: RePEc:oxf:wpaper:100
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Web page: http://www.economics.ox.ac.uk/
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  1. Lien, Donald & Liu, Lihong, 1996. "Futures Trading and Fuel Adjustment Clauses," Journal of Regulatory Economics, Springer, vol. 9(2), pages 157-78, March.
  2. Marshall, William J & Yawitz, Jess B & Greenberg, Edward, 1981. "Optimal Regulation under Uncertainty," Journal of Finance, American Finance Association, vol. 36(4), pages 909-21, September.
  3. Constantinides, G.M. & Donalson, J.B. & Mehra, R., 1997. "Junior Can't Borrow: A New Perspective on the Equity Premium Puzzle," Papers 97-24, Columbia - Graduate School of Business.
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  8. Crew, Michael A & Kleindorfer, Paul R, 2002. "Regulatory Economics: Twenty Years of Progress?," Journal of Regulatory Economics, Springer, vol. 21(1), pages 5-22, January.
  9. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, June.
  10. Rogerson, William P, 1980. "Aggregate Expected Consumer Surplus as a Welfare Index with an Application to Price Stabilization," Econometrica, Econometric Society, vol. 48(2), pages 423-36, March.
  11. Turnovsky, Stephen J & Shalit, Haim & Schmitz, Andrew, 1980. "Consumer's Surplus, Price Instability, and Consumer Welfare," Econometrica, Econometric Society, vol. 48(1), pages 135-52, January.
  12. Stennek, Johan, 1999. "The expected consumer's surplus as a welfare measure," Journal of Public Economics, Elsevier, vol. 73(2), pages 265-288, August.
  13. Holthausen, Duncan M, 1979. "Hedging and the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 69(5), pages 989-95, December.
  14. Severin Borenstein, 2002. "The Trouble With Electricity Markets: Understanding California's Restructuring Disaster," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 191-211, Winter.
  15. Gilbert, Christopher L, 1985. "Futures Trading and the Welfare Evaluation of Commodity Price Stabilisation," Economic Journal, Royal Economic Society, vol. 95(379), pages 637-61, September.
  16. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, June.
  17. Hanoch, Giora, 1977. "Risk Aversion and Consumer Preferences," Econometrica, Econometric Society, vol. 45(2), pages 413-26, March.
  18. Hogan, William W, 2002. "Electricity Market Restructuring: Reforms of Reforms," Journal of Regulatory Economics, Springer, vol. 21(1), pages 103-32, January.
  19. William Vickrey, 1971. "Responsive Pricing of Public Utility Services," Bell Journal of Economics, The RAND Corporation, vol. 2(1), pages 337-346, Spring.
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