By Chris Harris (auth.)
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Extra info for Fixed and Variable Costs: Theory and Practice in Electricity
Even in the simplest analysis of understanding electricity costs in order to set tariffs, we have found a very unclear boundary between fixed and marginal costs. We can unravel the established development of discussions of fixed and marginal pricing (the state of which, in the period of Dupuit in 1844 to the present day, is most unsatisfactory for electricity pricing) in a number of ways that we describe here. 26 l Fixed and Variable Costs We will see that much of the debate hinges around the discretion in the allocation of costs, and the real effect that value 2 and accounting treatment has on optimal behavior.
It can also apply to the softening of hard boundaries, such as running the plant slightly beyond capacity or beyond its specified engineering life. Since the world with soft constraints is so important when considering marginal costs, we generally regard hard constraint modeling as a special case of soft constraints. 1 shows the hard capacity constraint. On the left we have a standard model, with constant variable costs up to a capacity constraint at which variable costs become infinite. The figure on the right shows the same plant unit with a different vertical axis, which will become important later on.
The important themes are: 1. Flexibility—where a contract can be reopened or modified by mutual agreement, but usually contains considerable friction cost and commercial risk that commonly requires sharing of the commercial opportunity of the change with the contracting party. 2. Behavior—it remains common for firms not to exercise their contracts optimally, for example, they may produce according to a hedge profile rather than respond to live market signals. 3. Gaming—market behavior can take the appearance of a contracted game, for example, two players responding to one another’s price/volume behavior.