D. Summary
In the first stage of calculating LRMC, the economic (first
best) efficiency objectives of tariff setting are satisfied, because
the method of calculation is based on future economic
resource costs rather than sunk costs, and also incorporates
economic considerations such as shadow prices and externalities.
The structuring of marginal costs permits an efficient
and fair allocation of the tariff burden on consumers. In the
second stage of developing an LRMC-based tariff, deviations
from strict LRMC are considered to meet important financial,
social, economic (second best), and political criteria. This
second step of adjusting strict LRMC is generally as important
as the first stage calculation.
The LRMC approach provides an explicit framework for
analyzing system costs and setting tariffs. If departures from
the strict LRMC are required for noneconomic reasons, then
the economic efficiency cost of these deviations may be estimated
roughly by comparing the impact of the modified tariff
3 34 PROCEEDINGS OF THE IEEE, VOL. 69, NO. 3, MARCH 1981
relative to (benchmark) strict LRMC. Since the cost structure
may be studied in considerable detail during the LRMC calculations,
this analysis also helps to pinpoint weaknesses and
inefficiencies in the various parts of the power system-for
example, overinvestment, unbalanced investment, or excessive
losses at the generation, transmission, and distribution levels,
in different geographic areas, and so on. This aspect is particularly
useful in improving system expansion planning.
Finally, any LRMC-based tariff is a compromise between
many different objectives. Therefore, there is no “ideal”
tariff. By using the LRMC approach, it is possible to revise
and improve the tariff on a consistent and ongoing basis, and
thereby approach the optimum price over a peeod of several
years, without subjecting long-standing consumers to “unfair“
shocks, in the form of large abrupt price changes.
11. ECONOMICOS F MARGINALC OST PRICING
Marginal cost pricing theory dates back to the pathbreaking
efforts of Dupuit [ 111 and Hotelling [ 171, [47] , [48]. The
development of the theory, especially for application in the
electric power sector, received a strong impetus from the
1950 s [ 2 ] , [ 3 ] , [ S l ] , [ 5 4 ] , [ 5 7 ] . Recent work hasled to
developments in peak load pricing, incorporation of the effects
of uncertainty and the costs of power shortages, etc. [71,
[ 201, [26], 1491, [ 531, [ 55 I . This section briefly reviews
the basic principles of marginal cost pricing and some recent