Introduction

The aim of this chapter is to introduce basic concepts of welfare economics and industrial organization that shall be used throughout the book, and to introduce the paradigm of the regulated firm that we use throughout our discussion. We intend neither a full and complete treatment of these concepts nor an elementary textbook treatment of the material. Such is available elsewhere. Our intent is to provide a brief and nontechnical introduction to those ideas used most frequently in chapters subsequent to this.

We assume that the objective of regulators in setting prices is to maximize social welfare, broadly defined. Pricing policy serves this function in two ways: directly, by redistributing wealth in society, and indirectly, by signalling a reallocation of resources in society.

So called lifeline service that offers minimal service at low rates to poor people and the elderly is often a redistribution to these groups from the company and other consumers. It achieves the social purpose of providing public utility service to those who would not otherwise be able to afford it. This is an example of the redistributive function of pricing policy. As an example of the reallocative effect of pricing, imagine that the utility were to offer an optional day/night tariff constructed to yield the same revenue to the company as some existing tariff. Consumers cannot lose by such an offering to the extent it is indeed optional.