The authors respond:</h1> <p>Jim Johnston's letter gives us an opportunity to clarify our discussion of electricity pricing. In our article we argued that there were two important defects of traditional electricity regulation from the perspective of economists: excess incentive for capital-intensive generation techniques and the use of prices as revenue-recovery rather than resource-allocation devices. Regulated retail prices for electricity consumption are weighted-average rather than marginal cost and thus incorrectly signal consumers about the true costs of electricity production: too high off-peak and too low on-peak.</p> <p>In a true deregulated market, Johnston is correct that consumers would be offered choices about how much of the continuous wholesale price variation they would face, ranging from all to none-just like mortgage products range from continuously adjustable to 30-year fixed-rate, even though the spot price of capital varies continuously.</p> <p>If genuine deregulated electricity markets are not possible, we argued that regulation could "mandate" real-time pricing. Our use of the term mandate was unfortunate because it implies that we would oppose the use of the risk-hedging and long-term contracts that Johnston describes. In addition, our use of the term allowed Johnston to infer that we favor mandating particular market institutions such as the California spot market. We neither oppose the use of the contracts Johnston describes, nor do we favor mandating any particular type of market institutions. What we do not favor is the suppression of prices as resource allocation signals through regulation. <i>-Jerry Taylor and Peter Van Doren</i></p> </p>&nbsp;</p> <p><b>Articles found on this page are available to subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.</b></p>