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The main aim of this paper is to develop an econometric approach to estimation of marginal costs of improving quality of service. The authors implement this methodology by way of applying it to the case of the UK electricity distribution networks. The estimated marginal costs allow them to shed light on the effectiveness of the current UK incentive regulation to improve quality, and to derive optimal quality levels and welfare losses due to sub-optimal quality levels. The proposed method also allows them to measure the welfare effect of the observed quality improvements in the UK between 1995 and 2003.
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