Comparing Welfare Effects of Different Regulation Schemes: An Application to the Electricity Distribution Industry

Abstract

We compare the welfare effects of different regulation schemes of electricity distribution utilities. The compared regulation schemes are fixed price regulation, cost of service regulation, menu of cost-contingent contracts and simple menus of contracts. In our calculations we utilize the information of firm specific potential to improve cost efficiency. The firm specific cost information of Finnish electricity distribution utilities is obtained by using various Stochastic Frontier models. Our basic result is that welfare can be improved by changing the cost of service regulation scheme to the menu of contracts regulation. Welfare also increases in the case of fixed price regulation and simple menus of contract regulation. There is however, a significant difference among regulation regimes on how this improved welfare is distributed to consumers and producers.

Keywords: welfare, regulation, benchmarking, stochastic frontier analysis, cost efficiency, heterogeneity, electricity distribution

JEL Classification: C13, C23, D6, D24, L51, L94