Problem 3: Ramsey Pricing, FDC pricing, and Fairness tests. A utility company se
ID: 1113061 • Letter: P
Question
Problem 3: Ramsey Pricing, FDC pricing, and Fairness tests. A utility company sells electricity to residential and industrial consumers. The demand for residential electricity is Q1 = 30 P1, and the demand for industrial electricity is Q2 = 24 P2. The total cost of producing electricity is T C = 328. That is, the firm only has to pay a fixed cost of 328, and there are no marginal costs.
(a) What are the Ramsey prices? You can use the formula for Ramsey prices with = 0.5.
(b) Now consider FDC pricing where the fixed cost is divided as follows. Residential consumers cover 200 (around 61 percent), and industrial consumers cover 128 (around 39 percent). What are the FDC prices? Note: There will be two prices for each consumer. Specify the lower price.
(c) Now assume that for a firm that producing only residential electricity, the total cost is 200. For a firm that only produces industrial electricity, the total cost is 320. Do Ramsey prices pass the stand-alone average cost test? The average incremental cost test? Repeat the question for FDC prices.
Explanation / Answer
a) The demand for residential electricity is:
Q1 = 30 P1 and,
the demand for industrial electricity is:
Q2 = 24 P2.
The total cost of producing electricity is TC = 328. Since, there are no marginal costs thus,
Ramsey Prices for Residential electricity= 328+30= 358
Ramsey Prices for Industrial electricity = 328+24= 352
b)FDC pricing Fixed cost components:
Residential consumers cover 200 (around 61 percent) and,
Industrial consumers cover 128 (around 39 percent).
Price Calculation= Fixed cost*Total Cost*Margin over cost
Price for Residential Consumers= 200*358*.61
=$ 43,676
Price for Industrial Consumers=128*352*.39
= $ 17,571.84
Hence, Industrial consumers have the lower price.
c) Now Total cost for Firm producing Residential Electricity=200
Total cost for Firm producing Industrial Electricity= 320
We know
Q1 = 30 P1 and,
the demand for industrial electricity is:
Q2 = 24 P2.
Thus Ramsay Prices for:
Residential Electricity= 200+30= 230
Industrial Electricity= 320+24= 344
Price Calculation= Fixed cost*Total Cost*Margin over cost
Price for Residential Consumers= 200*230*.61
=$ 28,060
Price for Industrial Consumers=128*344*.39
= $ 17,172.48
The prices calculated here are much higher than the original prices. Hence, Ramsey prices pass the stand-alone average cost test and the average incremental cost test
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