The Pricing Dynamics of Utilities with Underdeveloped Networks
This paper uses an analytically tractable intertemporal framework for analyzing the dynamic pricing of a utility with an underdeveloped network (a typical case in most developing countries) facing a competitive fringe, short-run network adjustment costs, theft of service, and the threat of a retaliatory regulatory review that is increasing with the price it charges. This simple dynamic optimization model yields a number of powerful policy insights and conclusions. Under a variety of plausible assumptions (in the context of developing countries) the utility will find its long-run profits enhanced if it exercises restraint in the early stages of network development by holding price below the limit defined by the unit costs of the fringe. The utility's optimal price gradually converges toward the limit price as its network expands. Moreover, when the utility is threatened with retaliatory regulatory intervention, it will generally have incentives to restrain its pricing behavior. These findings have important implications for the design of post-privatization regulatory governance in developing countries.
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access to basic adjustment costs assume Bonfield conditional probability current profits decrease in future developing countries discount rate dominant utility dominant utility's e~rt early stages easy to show economic Euler equation exercise restraint expand its network firm future profits given high discount rate higher discount higher future illegal connections impact increasing function infrastructural services Lagrange multiplier limit defined limit price long-run profits low coverage ratios Mangasarian sufficiency conditions March 2007 March marginal costs marginal decrease maximum principle network development network expansion opportunities optimal price path plausible assumptions present value Hamiltonian price differential price increase pricing policy probability of regulatory profits very heavily regulatory penalties regulatory threat Research Working Paper respect to pricing retaliatory regulatory intervention revenues and profits rural saddle point shadow price significant network expansion stages of network steady-state terminal price theft of service underdeveloped networks unit cost utility's network expansion utility's optimal price variable Wijnbergen World Bank