Energy Pricing and Demand Management by Mohan Munasinghe

Author:Mohan Munasinghe [Munasinghe, Mohan]
Language: eng
Format: epub
Tags: Science, Environmental Science, Social & Cultural Studies, Political Science, Nature, Nonfiction, Environmental Conservation & Protection
ISBN: 9780429716386
Google: blqwAAAAIAAJ
Goodreads: 4904685
Publisher: Westview Press
Published: 1985-01-20T00:00:00+00:00

Shadow Pricing

In the idealized world of perfect competition, the interaction of atomistic profit-maximizing producers and utility-maximizing consumers gives rise to a situation that is called pareto-optimal. In this state, prices reflect the true marginal social costs, scarce resources are efficiently allocated and, for a given income distribution, no one person can be made better off without making someone else worse off.5

However, conditions are likely to be far from ideal in the real world. Distortions due to monopoly practices, external economies and diseconomies (which are not internalized in the private market), interventions in the market process through taxes, import duties, and subsidies all result in market (or financial) prices for goods and services, which may diverge substantially from their shadow prices or true economic values. Moreover, if there are large income disparities, the passive acceptance of the existing skewed income distribution, implied by the reliance on strict efficiency criteria for determining economic welfare, may be socially and politically unacceptable. Such considerations necessitate the use of appropriate shadow prices (instead of market prices) of inputs to the electricity sector to determine the optimal investment program as well as LRMC, especially in the developing countries where market distortions are more prevalent than in the industrialized countries.

The basic concepts of shadow pricing are summarized below, with special reference to so-called efficiency (shadow) prices, which emphasize efficient resource allocation and neglect income distributional considerations.6

In order to derive a consistent set of shadow prices for goods and services it is necessary to adopt a common yardstick or numeraire to measure economic value. For example, a rupee's (or dollar's) worth of a certain good purchased in a duty-free shop is likely to be more than the physical quantity of the same good obtained for one rupee (or one dollar) in a retail store, after import duties and taxes have been levied. Therefore it is possible intuitively to distinguish between a border-priced rupee, which is used in international markets free of import tariffs, and a domestic-priced rupee, which is used in the domestic market subject to various distortions. A more sophisticated example of the value differences of a currency unit in various uses arises in countries where the aggregate investment for future economic growth is considered inadequate. In such a case, a rupee of savings (which could be invested to increase the level of future consumption) may be considered more valuable in the national context than a rupee devoted to current consumption.

One numeraire that has proved to be most appropriate in many instances is a unit of uncommitted public income at border prices, which is essentially the same as freely disposable foreign exchange available to the government, but expressed in terms of units of local currency converted at the official exchange rate.7 The discussion in the next section is developed in terms of this particular yardstick of value. The border-priced numeraire is particularly relevant for the foreign exchange-scarce developing countries; it represents the set of opportunities available to a country to purchase goods and services on the international market.

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