Some Economic Insights on Prices and Choices

Josh Wright —  18 December 2007

Courtesy of Lynne Kiesling who supplies such insights regularly over at Knowledge Problem.  It’s about retail choice in electricity, but the general principles apply more broadly.  The whole thing is worth reading carefully:

There are, though, several ways that free choice and the removal of entry barriers into retail markets generates better outcomes than regulated monopoly service. When free choice allows consumers to choose among dynamic pricing options, they can face price signals and use technology to reduce their peak electricity use, leading to lower wholesale electricity prices and a reduced need to build costly infrastructure to meet peaks that just sits idle the rest of the time. 

Choice also encourages market entrants to bring differentiated products to market, to gain market share by appealing to different dimensions of consumer preferences and to reduce the extent of direct price-based competition. Product differentiation (and its associated price discrimination) benefits both consumers and producers (and thus creates surplus, or welfare, or value) in all cases except for some very special conditions. The connection between rivalry and product differentiation and economic value creation is one of the most unambiguous aspects of freedom of entry into retail markets.