Question

Suppose a natural gas distribution company has capital investments of 88 million and a capital cost r of 10%. The firm's operating, billing, and maintenance costs are $200,000. The firm buys natural gas at the city gate price of S5/MCF to sell to its customers. The firm distributes gas to those customers through its existing pipeline network at close to zero marginal cost The firm faces the following (inverse) demand by customer type (recall that these are average demand per customer, so at any given price you have to multiply quantity by the number of customers to get total quantity demanded in that customer group) . Residential 10,000 customers): P 50-5q Commercial (1,000 customers): P 50 q ·Industrial (100 customers): P = 20 q 100 a. (2 points) Calculate the linear average rate if the firm charges the same price to all three types of customers. What is the deadweight loss in this case? b. (1 points) If the firm charges P = MC to all customers, how large is its loss? c. (1 point) Calculate the two-part tariff if the firm charges each customer the same two-part tariff and charges P MC as the variable charge. What is the deadweight loss in this case? d. (3 points) Propose a two-part tariff that varies across the customer types and make an economic argument in support of your proposal. How does deadweight loss under your proposal compare to those you calculated above? e, (3 points) Suppose the regulator allows the firm a rate of return on capital s of 12%. How does that change the firm's revenue requirement? How does it change the firm's investment incentives? What does that do to the firm's costs, in general (not looking for a numerical answer here)

Answer 1