Pricing of Electricity: Is Two-part Tariff the Answer

The problem of unprofitable, as well as inefficient generation of electricity is attributed among other reasons, to the one-part tariff charged by the central electricity generating units from the state electricity boards (SEBs). We argue that the objective function of the SEBs depends on the consumers' surplus and the output generation from its own plants. We show that in the presence of a fixed consumer price of electricity, two-part tariffs cannot solve either problems. Even with a flexible consumer price, two- part tariffs can work only if the pricing scheme is designed so as to restrict over-production of electricity.