have often found that, when faced with multipart tariffs, consumers behave as if they are responding to the average price and not the marginal price., Conclusion The Commission takes the view that careful consideration of the ACT water market, including the regulatory process and any potential government policy considerations, is necessary when considering the structure of tariffs. Unless the complexities of the market are understood, standard economic approaches to setting prices may fail to deliver the best outcomes. For example, if consumers respond not to marginal costs but to average costs, setting price equal to marginal cost may not elicit the anticipated response. In the following discussion, the Commission attempts to tease out some of these complexities in more detail. Theoretical and practical issues Marginal cost pricing in a monopoly situation As noted in section , marginal cost pricing is a common approach applied when regulating monopoly utility prices as a means to promote the efficient use of utility infrastructure. There are a number of theoretical issues related to marginal cost pricing that have implications for setting water prices for a monopoly utility. These issues are discussed below. Benchmarking the socially optimal outcome Returning to the economic welfare concept first introduced in Chapter 3, we start with the first fundamental theorem of welfare economics. The first theorem is that when markets are complete, any competitive equilibrium is necessarily Pareto optimal. This theorem is a demonstration of Adam Smith’s hand’ of the market, which equates private goals with optimum social ‘invisible outcomes. The first theorem establishes the perfectly competitive case as a benchmark for considering optimal outcomes in market economies, and, perhaps more importantly, for thinking about optimal outcomes in cases of market failure, such as the natural monopoly example. As noted by Mas-Colell et al. (1995): In particular, any inefficiencies that arise in a market economy, and hence any role for a Pareto-improving intervention, must be traceable to a violation of at least one of the assumptions of this theorem. in principle, the analysis of Pareto optimal outcomes requires general equilibrium analysis that is, simultaneous consideration of the whole economy partial equilibrium analysis allows us to consider equilibrium outcomes in a particular market in isolation from all other markets. It also allows us to apply the concept of Marshallian surplus,
have often found that, when faced with multipart tariffs, consumers behave as if they are responding to the average price and not the marginal price., Conclusion The Commission takes the view that careful consideration of the ACT water market, including the regulatory process and any potential government policy considerations, is necessary when considering the structure of tariffs. Unless the complexities of the market are understood, standard economic approaches to setting prices may fail to deliver the best outcomes. For example, if consumers respond not to marginal costs but to average costs, setting price equal to marginal cost may not elicit the anticipated response. In the following discussion, the Commission attempts to tease out some of these complexities in more detail. Theoretical and practical issues Marginal cost pricing in a monopoly situation As noted in section , marginal cost pricing is a common approach applied when regulating monopoly utility prices as a means to promote the efficient use of utility infrastructure. There are a number of theoretical issues related to marginal cost pricing that have implications for setting water prices for a monopoly utility. These issues are discussed below. Benchmarking the socially optimal outcome Returning to the economic welfare concept first introduced in Chapter 3, we start with the first fundamental theorem of welfare economics. The first theorem is that when markets are complete, any competitive equilibrium is necessarily Pareto optimal. This theorem is a demonstration of Adam Smith’s ‘invisible hand’ of the market, which equates private goals with optimum social outcomes. The first theorem establishes the perfectly competitive case as a benchmark for considering optimal outcomes in market economies, and, perhaps more importantly, for thinking about optimal outcomes in cases of market failure, such as the natural monopoly example. As noted by Mas-Colell et al. (1995): In particular, any inefficiencies that arise in a market economy, and hence any role for a Pareto-improving intervention, must be traceable to a violation of at least one of the assumptions of this theorem. in principle, the analysis of Pareto optimal outcomes requires general equilibrium analysis that is, simultaneous consideration of the whole economy partial equilibrium analysis allows us to consider equilibrium outcomes in a particular market in isolation from all other markets. It also allows us to apply the concept of Marshallian surplus,