Tim Harford asks about inclining block rates …

Lynne Kiesling

… he just doesn’t realize it, or doesn’t know that it’s an established regulatory concept. Recently in his Undercover Economist blog, Tim Harford picked up on an idea floated by another FT columnist:

… we need tariff schemes that encourage conservation.

One option is “reverse pricing”, a simple framework that would increase the marginal cost of energy without introducing new taxes or raising average prices. This is important because marginal prices affect our behaviour, but total expenditure affects our wealth. So if we can increase one but not the other, we will create incentives to consume less without leaving households worse off overall.

Actually, what we need is retail competition, retail choice, and the removal of sclerotic and obsolete entry barriers that prevent motivated suppliers from providing innovative electricity-related products and services to residential retail customers. But I digress.

The pricing structure to which Tim alludes in his post is called “inclining block” pricing. When it emanates from a regulatory procedure, it is an inclining block rate. Inclining block pricing means that you price intervals of consumption, and the price per unit for each interval increases. For example:

  1. Block 1: 0-1000 kilowatt hours  $0.06/kwh
  2. Block 2: 1001-1750 kilowatt hours  $0.10/kwh
  3. Block 3: 1751-  kilowatt hours  $0.15/kwh

A few things to note. First, this logic is similar to that underlying David Zetland’s “some water for free, pay for more” proposals for water pricing. Second, the devil’s in the details when these rates are set by regulatory fiat; where do you draw the dividing lines, and what price per unit do you charge?

One of the best electricity economists, Ahmad Faruqui at the Brattle Group, has written extensively about the economic efficiency and conservation effects of inclining block pricing. In that list of resources I’d also recommend this NRRI report for regulators on how and why to consider “economic rates”, including inclining block pricing.

3 thoughts on “Tim Harford asks about inclining block rates …

  1. We have such block pricing for water here in the south of Portugal. Basic supply, for showers, running a washing machine etc is a very reasonable indeed 20 euro or so a month. Start watering the garden in the summer and as the meter ticks over the rate per litre (or whatever) starts rising. Try actually irrigating some land and bills rapidly climb to the hundreds of euros per month. There are, I think, three price bands.

    A friend wasn’t using his laid in drip irrigation system….but it was leaking. That first bi monthly bill for hundreds had him digging up the garden to find the leak pretty quickly.

    It also encourages those of us with gardens to collect winter rain in cisterns so as to be able to water the garden in summer. All round a very good system indeed.

  2. “If you don’t know where you’re going, any road will get you there.”, The Mad Hatter

    “You’ve got to be careful, if you don’t know where you’re going, because you might end up someplace else.”, Yogi Berra

    Regulators, frustrated by their inability to regulate nature, focus on regulating utilities instead.

    Water is a nature-limited resource, absent massive investment in desalination facilities. Typically, if too much water is used, the supply could be exhausted. Inclining block rates are a reasonable response to this situation, as are absolute use restrictions for non-essential applications.

    Electricity, on the other hand, is generally not permitted to be a limited resource by regulation. (CA was an exception a decade ago, but that was largely water related.) Electricity, however, is generally more expensive to produce and deliver during periods of high use, typically on hot summer afternoons during the work week. The issue, in this case, is not an overall monthly limitation on electric availability, since the electric system is typically capable of delivering more than twice as much electricity as it does on a monthly basis. Rather, it is an issue of production efficiency and cost as well as T&D losses.

    Therefore, inclining block rates might be a moderately effective approach to limiting total electricity consumption, but not necessarily or even likely an effective approach to improving system efficiency. Arguably, any electric rate structure other than real time rates, is a less effective proxy applied for some reason other than economic efficiency.

    As the two quotations at the beginning of the post illustrate, it is important to understand what you are attempting to accomplish before you select the method of accomplishing it.

  3. Tim needs to do better lit (er, blog) reviews before he comes up with such “good” ideas 🙂

    The details do matter, a lot. I just wrote about IBR that were steep but didn’t kick in for a LONG time. In other words, they were uniform blocks in disguise…

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