Old Problems, New Challenges
Chapter 10: Public utility pricing and rate setting
In market-based economies, prices charged for most goods and services generally are a reflection of supply and demand. When supply exceeds demand, prices fall. When demand exceeds supply, scarcity appears and prices rise. This is the The model does not work in exactly this way when pricing the products and services of public utilities. External forces in the form of government regulations and political considerations often intervene in the price-setting process. Furthermore, federally mandated restructuring of the utility industry has introduced a new complexity into the practice of setting prices at all levels of the utility industry. The fundamentals of rate setting, price-setting practices, and such special pricing considerations as social pricing are discussed in the following paragraphs. Throughout the chapter the terms and may be used synonymously, although in the industry, are sometimes (but not always) used to describe the wholesale cost of a utility product, with used to mean the retail price of the product.Managers in most businesses approach the rate-setting process from two interrelated positions. The first begins with the overall revenue requirements of the organization: income must meet all debt services, operating costs, and provide an appropriate return to investors. The second begins at the opposite end of the chain: determining what specific combination of prices, rate structures, and rate schedules will bring in the revenue required. This model is more complicated when the organization or business is a public utility.Another set of conditions underlies the rate-setting decisions of utility managers and state and federal regulators,...
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