Transcript An Empirical Analysis of Ramsey Pricing in Japanese

An Empirical Analysis of Ramsey
Pricing in Japanese Electric
Utilities
BY: ISAMU MATSUKAWA, SEISHI MADONO
AND TAKAKO NAKASHIMA
PRESENTED BY: SARAH NOLL
Introduction
 Very few studies have be conducted on the Japanese
electric utilities. This study investigates whether the
regulated prices satisfy the Ramsey pricing conditions.
 Japanese electric utilities are local monopolies and are
subject to regulation.
 The price of electricity is determined by the Fully
Distributed Cost (FDC) method.


Common costs are allocated to service based on their relative shares
of output, peak demand, revenue, attributable cost, etc.
Therefore, the unit price for industrial customers served at higher
voltages is less than the unit price for residential customers.
Introduction
 Japanese electricity utilities provide services in
competitive and noncompetitive markets.
 Self-generation and cogeneration have grown due to
lower prices of oil, coal, and gas.


Increased competition in the supply and distribution of electricity
A higher portion of common costs is passed onto remaining
customers
 Creates a cycle of customers switching to alternative
generation and higher prices for those that are left with
the utility.


The socially inefficient outcome in which losses for utilities and
remaining customers exceed the benefits of customers using selfgeneration and cogeneration may result.
Solution: Ramsey Pricing.
Introduction
 Constructed an econometric model of electricity
production and demand to examine the effect of
regulation on electricity prices in Japan.


Sample of 9 utilities from 1980-1988.
Tests whether observed patterns of electricity prices satisfy the
Ramsey pricing conditions.
 If the pricing patterns are not different from Ramsey
pricing, the increase in self-generation and
cogeneration will not necessarily bring about a
socially inefficient outcome.
The Model
 Ramsey Pricing
 Two assumptions:
(1) the multiproduct monopoly has scale economies and
alternative generation sources do not and
 (2) outputs of the multiproduct monopoly are imperfectly
substitutable for those of alternative generation sources, the
second-best prices must satisfy the condition that, for all products
provided by the natural monopolist,

The Model
 The Ramsey Rule:
 Low elasticity markets get high markups
 High elasticity markets get low markups
 No regulation of alternative generation sources is required
 An advantage is that is less costly because only the monopolist
is regulated
Cost Function for the Electric Utilities
 Marginal cost estimates for each output are obtained
from estimation of a three-factor translog
multiproduct cost function


Only using industrial and residential customers
Assume that the two customer groups have identical marginal
costs and aggregate these two classes when estimating the
utility’s cost function
Fuel Costs Function for Industrial Customers
 The translog functional form is used to represent the
energy cost function for industrial customers as:
 Fuel Cost Share Equation:
Fuel Costs Function for Industrial Customers
 Price Elasticities for Purchased Power from the
utility are given by:
Fuel Expenditure Function for Residential
Customers
 For the almost ideal demand system, the total fuel
expenditure function of residential customers is
given by:
Data and Estimation Methods
 The cost share equation for gas is deleted to avoid
singularity in the fuel cost share equation for industrial
customers.
 For the residential fuel expenditure function, restrictions
on parameters are imposed to satisfy homogeneity of
degree zero in prices and total fuel expenditure and
Slutsky symmetry:



All equations of the fuel demand system must have joint normal
additive disturbances
The iterative Zellner efficient estimation procedure is used to obtain
maximum likelihood estimates
The expenditure equation for kerosene is removed from the system
to avoid singularity
Estimation Results
 Region-Specific effects on cost and demand
structures are examined by including region-specific
constants in the cost function of the utility and fuel
cost function of customers.


Results show that region-specific effects are not significant for
all cross-section units of residential customers.
For industrial customers the fuel cost function had significant
coefficients for most regional dummies.
Estimation Results
 The assumption that parameters in electricity cost
and demand functions are identical throughout the
entire estimation period may not be appropriate
because of the effects of shocks associated with
technological and or institutional factors on the
economic behavior of the utility and customers.

The Chow test was used to test the stability of estimated
coefficients,
Two periods 1980-1984 and 1985-1988
 Do not reject the hypothesis that the relationship is stable for both
electricity cost and demand functions

Estimation Results
 All three own-price elasticities are negative
 Fuel has the largest own-price elasticity , which can
possibly reflect the fact that fuel input is relatively easy to
adjust when input prices change.
 Positive values of cross-price elasticity indicate
substitutability.
Estimation Results
 All four have negative own-price elasticities
 On average coal is the highest
 Positive values of cross-price elasticity indicate
substitution possibilities between the fuels
Estimation Results
 Electricity is a substitute for gas and a complement
for kerosine.
 Gas has the highest own-price elasticity.
Estimation Results
 Second-best pricing by the electric utility was tested using
condition (1).
 T-stat implies that the null hypothesis of equality in
Ramsey numbers is rejected at the 0.01 significance level.
Statistical Test for Ramsey Pricing
 The regulated prices of electricity in Japan for the
period 1980-1988 did not satisfy the Ramsey pricing
rule.
 Social welfare can be raised by choosing alternative
sets of electricity prices that satisfy the Ramsey
pricing conditions.
 The estimates of Ramsey numbers on average for
industrial customers are 0.210 and 0.062 for
residential customers. Positive numbers indicate
both customers faced electricity prices above
marginal costs.
Numerical Example of Ramsey Prices
 Estimates of Ramsey optimal prices for residential
and industrial customers.
 35% increase in Residential prices would be required
Conclusion
 Price effects on residential and industrial electricity
demand are not negligible and electricity turns out to be
a substitute for other fuels.
 Markups of price over marginal cost are positive for both
residential and industrial customers, with residential
markup small than that for industrial customers.
 The test result rejects the hypothesis that the rate
regulation satisfies the Ramsey optimal criteria, and the
movement from actual prices to Ramsey prices may
require:


A large increase in residential prices
A slight decrease in industrial prices