Last week I posted a blog about how wholesale electricity markets work. This week, I'd like to summarise some of the literature in relation to price dispersion in retail markets.
So, how do economists define whether pricing is 'efficient'. A new paper in Energy Economics by Simshauser and Whish-Wilson sums up the literature by stating, 'Efficient pricing requires the marginal unit produced to be priced at marginal cost.' The same paper concludes that electricity pricing in Victoria meets this criteria.
A second question I often get asked is why are prices different? This is not just a question I get asked about energy but all kinds of products. I get asked: 'Why do students get discounts at the movies? Is it because the cinemas feel sorry for them?' I can't answer the second question conclusively but I know that the economics literature talks about the concept of price discrimination.
Price discrimination as a concept goes all the way back to the works of economists such as Pigou (1920). There are three basic forms of price discrimination:
- First-degree – a monopolist effectively prices each customer differently based upon their willingness to pay reflected through a downward sloping demand curve. Economists generally advocate for the economic regulation of natural monopolies.
- Second-degree – non-linear pricing is utilised to provide discounts based on quantity consumed.
- Third-degree – market segmentation is utilised to base individual pricing for particular classes of customers on their willingness to pay (e.g. pensioner discounts at the cinema).
It is a shame that it is called 'price discrimination' as economists generally indicate that it often has a positive outcome. For example, cinemas know that if they charged the full price, students may not go to the movies as much. By reducing the price for students, they ensure more students go to the movies.
But what does all this mean for electricity? Well, it emphasises the importance of shopping around as there are many different companies and tariffs to choose from. One of my own papers from several years ago pointed out the significant savings that could be obtained from shopping around to find the best deal for your unique consumption profile.
In the coming weeks, I will hopefully provide another blog post on a paper I'm working on with evidence about how price dispersion in electricity markets somewhat reflects quantity consumed (the second criteria above).