the magnitude and structure of strict LRMC. Changes in tariff
structure at this stage will be based mainly on sociopolitical
factors, e.g., differentiation by type of consumer (residential,
commercial, industrial and so on), or by income level (low-,
middle-, and high-income residential). Practical considerations
such as the difficulties of metering and billing will also affect
the fiial tariff structure.
The constraints which necessitate deviations in the final
tariffs relative to strict LRMC fall into two categories [ 301.
The first group consists of distortions which may be analyzed
basically within an economic framework, i.e., second best considerations
and subsidized (or lifeline) tariffs for low income
consumers. In these cases, it is possible to quantify the extent
of the deviation from strict LRMC by using an appropriate
pricing model and explicit system of shadow prices instead of
market prices. Strict (shadow-priced) LRMC also deviates
from the market-priced LRMC, and this is done to correct for
distortions in the economy. Therefore, the constraints which
force further departures from strict LRMC (in the second stage
of the tariff setting procedure) may also be considered consequently
as distortions which impose their own shadow values
on the calculation. The second group includes all other con340
PROCEEDINGS OF THE IEEE, VOL. 69, NO. 3, MARCH 1981
siderations such as financial viability, sociopolitical constraints
and problems of metering and billing where strict economic
analysis is difficult to apply. These two groups of constraints
may be interrelated, e.g., subsidized tariffs can simultaneously
have economic welfare, financial and sociopolitical implications.
A. Second-Best Considerations
Where prices elsewhere in the economy, especially of substitutes
and complements for electric power, do not reflect
marginal costs, a “second best” departure from a strict marginal
cost pricing policy for electricity services may be required.
More generally, price distortions affecting inputs into
the production of electric power and outputs of other sectors
which are electricity intensive (e&, aluminum) should also be
considered. The former type of distortion may be dealt with
by direct shadow pricing of inputs as discussed earlier, but the
latter case (although quite rare) requires more detailed analysis
of the market for the output. As an example of price distortion
for an energy substitute, consider the subsidies for imported
generators and/or diesel fuel, which exist in some
countries. This may make it advantageous for users to set up
their own captive plant, even though to the economy as a