6 Responses to Consumer surplus and electricity markets
When compared to the value of the service they provide, U.S. electric rates are an astonishingly good deal
Richard W. Caperton begins the first in a weekly series of articles on how utility decisionmaking, regulatory structures, energy markets, and consumer behavior all impact the massive deployment of renewable energy and energy efficiency products. Caperton is a Senior Policy Analyst at the Center for American Progress.
My colleague Matt Yglesias recently made an important point about how competitive markets can benefit consumers:
Think about your standard refrigerator/freezer. It’s sort of a miraculously useful device. Instead of your food turning stinky and rotten, it sits nicely in my fridge. The direct financial value of being able to store leftovers or freeze excess raw ingredients is significant, over and above the convenience value. You can spend a lot on one of these miraculous devices if you’re so inclined, but you can also get one for a few hundred bucks. That’s because the market for fridges is quite competitive””lots of different manufacturers, lots of different vendors””so at the less stylish end of the market, the sale price approximates the construction costs. And the construction costs are low, crazy low relative to what you’d be willing to pay to a refrigerator monopolist. If the cheapest fridge out there cost $5,000 I’d still want one and I bet you would too.
Consumer surplus – the extra value that consumers derive from a product that is above and beyond the price they paid – is an incredible economic tool. In fact, it’s even codified in US regulatory proceedings. The Office of Management and Budget says that consideration should be given to both consumer and producer surpluses when examining new regulations. As consumers, we generally prefer consumer surplus, which is why we’d rather pay $500 for a refrigerator, even though Yglesias may be willing to pay $5,000.
Healthy competition in the appliance market has undoubtedly led to massive consumers surpluses. It turns out that electricity markets, which are largely based on a unique “regulated monopoly” model, also provide for consumer surplus.
Consider this: The average American residential consumer pays about 11.5 cents per kwh for electricity. Yet, we would be willing to pay as much as 100 times that amount in a completely free market! For example, researchers at the University of Maryland found that the average “value of lost load” (i.e., the maximum price people would be willing to pay for electricity to avoid an outage) is between $2.40 and $20.00 per kwh, or 20 to 200 times as much as the average retail rate.
Of course, value of lost load studies are based on what someone would pay to avoid an outage, so people may not be willing to pay these prices in the long-term. Put another way, once you’ve already installed lights in your house, you’re probably willing to pay extremely high rates for short periods of time to keep them on, but the decision to install lights is based on expectations of low rates. If you expected extremely high rates, you probably wouldn’t install as many lights.
Lost in all the debate about how much power from clean energy sources would cost, and how environmental compliance affects rates, is that our electricity is an astonishingly good deal. Even if clean energy did raise electric rates, which isn’t completely certain, there’s absolutely no indication that rates would go up enough to make any meaningful difference in the level of consumer surplus.
It’s also important to note that this consumer surplus is a direct result of a regulatory system that is designed to provide reliable power at the lowest possible cost. The system has been tweaked over the years, and is certainly far from perfect, but it is sort of incredible to think that we have exceptionally high-quality electricity in our homes at about 1/100th of the price that we would be willing to pay.
This success story makes me optimistic that we can build new things into our regulatory system, like the need to dramatically de-carbonize electricity generation. I’m confident that policymakers – with the help of engineers, economists, and other experts – can design a regulatory system that will work for the future. The challenge seems to be in making them understand the high cost of failing to do so.