Question

1. Income and substitution effects in the analysis of a public policy.
A spike in the cost of electricity in Ontario has occurred (eg, one of the main power stations suffers a
major accident, OR we could be considering a move to market pricing of electricity). The government is
considering proposals to finance electricity costs for poorer families, to offset an expected sharp rise in
the cost of electricity that is expected to occur next year. Briefly compare the following two proposals in
terms of in terms of (i) the extent to which each program results in energy conservation and (ii) the likely
size of public expenditure. Finally, (iii) predict which program recipients would prefer to see
implemented.
a) The government pays the difference between a household’s electricity expenditure in the coming year
(after the increase in price) and its expenditure in the prior year (before the price increase).
b) Each eligible household is given a voucher to be used only for paying for electricity. The value of the
voucher is the expected cost increase for the same quantity(kilowatt hours) of electricity as the household
consumed last year before the price increase took place.
Use indifference curve diagram(s) and explain your answers briefly. If you cannot reach a definite
conclusion, briefly discuss the additional information that would be required to do so.

Answer 1

• The structure of the electricity sector has been evolving over the past decade. In most provinces, there has been a shift from vertically-integrated electric utilities (often provincial Crown corporations) to various degrees of market liberalization and/or unbundling of generation, transmission and distribution services. The electricity Ontario Power Generation generates costs about 40% less than the average price paid to other generators in the province. Unlike other generators whose prices are set in their contracts, OPG is Ontario's only 'regulated' generator, whose prices are determined through an open, public review by the OEB.