Lect - Energy Economic - EM

04‐03‐2023
Energy Economics
PGDM(EM) 2023
(1st – 4th March 2023)
By:
Prof. Brijesh Bhatt
Assistant Professor
NTPC School of Business
Overview
Economics of Energy Supply
Session 6: Economics of Electricity Supply (Chapter 10)
Session 7: Economics of Renewable Energy Supply (Chapter 11)
Energy Markets
Session 8: Principles of Energy Pricing (Chapter 12)
Session 9: Energy Pricing & Taxation (Chapter 13)
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Lecture Outline
I. Introduction
 Firm & it representation: Production Function
 Economic and accounting profit/cost
II. Cost Functions of Firm

 Fixed and Variable Costs
 Average Costs
 Marginal Cost
III. Market Structures
IV. Market and Pricing

 Firm in a perfectly competitive market
 Firm in a monopoly market
1. Firm, theory of firm and

production function
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Nature of the firm
 A firm is an organisation that brings together different factors of production

(inputs), such as labour, land and capital, to produce a product or service (output),
which it hope, can be sold for a profit.
What do firms do?

At the most fundamental level, firms take inputs and transform them into outputs.
Profit:
Accounting profit differs from economic profit.
Normal profit may be defined as: a minimum level of reward required to ensure that existing
entrepreneurs are prepared to remain in their present area of production.
profits = total revenues – total costs
For economists, an alternative formula is required:
economic profits = total revenues – total opportunity cost of all inputs used
Economic Profit
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Question
You start a consulting firm after college. Your total revenues are $250K per year.
Your cost for office supplies, office space, employees, and travel is $200K per year.
Suppose you could get a job in McKinsey and Company making $75,000 per year.
Find accounting and economic profit
Accounting Profit – 50 K
Economic Profit - -25 K
Theory of firm
 Profit‐maximization is regarded as the main objective when considering a firm’s behavior
 In pursuit of profit‐maximization, how a firm makes cost‐minimizing production decisions and how the firm’s
resulting cost varies with its output.
 All firms must make several basic decisions to achieve what we assume to be their main objective i.e., profit‐
maximization
i. Which production technology to use: How inputs can be transformed into outputs.
ii. Input choice: Given its production technology and the prices of its inputs, the firm must
choose how much of each input to use in producing its output
iii. How much outputs to supply: Based on market price.
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A firm’s technical representation: Production Function
Production Function: It refers to a function showing maximum output that

a firm can produce for every combination of inputs at a particular time.
• General production function is expressed as:

𝑋 𝑓 𝐿, 𝐾, 𝑅, 𝐸
Where,
X= Level of output
L= Labour
K= Capital
R= Raw materials
E= Technological Efficiency
Ceteris paribus
Production in short-run versus long-run
Short-run is a period in which firms can adjust production by

changing variable factors such as materials and labour but
cannot change quantities of one or more fixed factor such as
capital, land etc.
Long-run is a period long enough to permit changes in all factors
of production.
Short – run :
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Production Function
Input of labour Total product (output in
sq.m. per week )
0 0
1 20
2 60
3 120
4 140
5 150
6 160
7 165
8 163
Production in short-run
Short – run :
The contribution that labour makes to the production process can be described on both an average and
marginal basis
 Marginal product of labour: It is the additional output produced as the labour unit increases by one unit. It is the change
in the output quantity fron a unit increase in labour input
It is written as /
 Average product of labour: It is the output per unit of labour input. It is calculated by dividing the total output (q) by the
total input of labour (L). It is written as q/L
 Total product of labour: It is the total quantity of goods produced by a firm during a specified period of time
(TPL)
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Production in short-run
Diminishing returns and law of diminishing (marginal) returns: As the proportion of
one factor in a combination of factors is increased, after a point, the marginal
product of that factor will diminish.
Example: A hypothetical case in construction
Input of labour Total product Marginal physical
(output in sq.m. per product (in sq. m
week ) per week)
0 0
1 20 20
2 60 40
3 120 60
4 140 20
5 150 10
6 160 10
7 165 5
8 163 ‐2
Diminishing Marginal returns

14
Units of Output
196 Total Product

184
161
Q from hiring fourth worker
130
Q from hiring third worker
90
Q from hiring second worker

30
Q from hiring first worker
1 2 3 4 5 6 Number of Workers
increasing diminishing
marginal marginal
returns returns
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Production in long-run
Long – run : 𝑋 𝑓 𝐿, 𝐾 Where both labour (L) and capital (K) are vary
Capital Labour input

input
1 2 3 4 5
1 20 40 55 65 75
2 40 60 75 85 90
3 55 75 90 100 105
4 65 85 100 110 115
5 75 90 105 115 120
Long‐run production function can be represented graphically by iso‐quants
Production in long-run
Isoquant: A graph that shows all the combinations of capital and labour that can be
used to produce a given amount of output.
Isoquants showing all combinations of capital and labour
that can be used to produce 50, 100, and 150 units of output
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Long-run production
● Returns to scale: Rate at which output increases as inputs are increased

proportionately.
● increasing returns to scale Situation in which output more than doubles

when all inputs are doubled.
● constant returns to scale Situation in which output doubles when all

inputs are doubled.
● decreasing returns to scale Situation in which output less than doubles

when all inputs are doubled.
2. The cost of production
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Measuring costs: which costs matter?

Profits of a firm is given by:
Profits = Total revenues – Total costs
The total costs is sum of total fixed cost and total variable costs as economists, like to make a distinction
between fixed costs and variable costs, which we explain below.
Total costs = Total fixed costs + Total variable costs
Fixed costs: All costs that do not vary – that is, costs that do not depend on the rate of production – are
called fixed costs.
Variable costs: Costs that varies with the level of output
Measuring costs: which costs matter? …cont.
Understand characteristics of production cost is important so as to identify fixed cost, sunk cost
and variable cost:
Examples:
Fixed cost versus sunk cost versus variable cost:
• Fixed cost: Salaries of key executives and expenses for their office space etc.
• Sunk cost: Cost of R&D to a pharmaceutical company to develop and test a new drug, cost of a
chip‐fabrication plant to produce microprocessors for use in computers etc.
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Costs in the short-run: Total cost
• Total cost (TC) = Total cost comprises of two kinds of costs, namely
total fixed costs and total variable costs i.e. TC = TFC + TVC
• Total fixed cost (TFC) = Any cost that does not depend on the firm’s
level of output. These costs are incurred even if firm is producing
nothing. There are no fixed costs in the long run. It includes cost of
the machinery.
• Total variable cost (TVC) = A cost that depends on the level of
production chosen. It includes cost of direct labour, raw material etc.
Source: Myers 2009
Costs in the short-run: average & marginal cost
• Average cost (AC) = It is cost per unit of output produced i.e. AC =
Total cost (TC) / Output (Q) or AC = AFC + TVC
• Average fixed cost (AFC) = It is the fixed cost per unit of output. AFC
declines as quantity increases.
AFC = TFC / Q
• Average variable cost (AVC) = It is the variable cost per unit of output.
AVC = TVC / Q
• Marginal cost: It is the additional cost incurred as output is increased
by one more unit. Because fixed costs does not change as the firm’s
level of output changes, marginal cost is equal to the increase in
variable cost or the increase in total cost that results from an extra
unit of output. We can therefor write marginal cost as :
∆𝑇𝐶 ∆𝑇𝑉𝐶
𝑀𝐶
∆𝑄 ∆𝑄
Source: Myers 2009
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Average And Marginal Costs
Cost MC
$4
AFC ATC
2 AVC
0 30 90 130 161 196

Units of Output
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Example
Fixed Variable Output Average Delta Q Delta L (L2‐ Marginal

input (K) input Q=Q(k,L) productivity (Q2‐Q1) L1) product of
(L) of variable variable input
input (AP) = (MP=delta Q/
Q/L delta L)
6 1 65
6 2 160
6 3 300
6 4 420
6 5 550
6 6 678
6 7 763
6 8 840
6 9 882
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Example
Fixed Variable Output Total Total Total cost Average Average Average Delta C Marginal
input (K) input Q=Q(k,L) fixed cost variable (TC) fixed cost variable cost =(TC2 ‐ cost (MC)
(L) (TFC) cost (AFC) = cost (AC) = TC1) = (delta C
(TVC) (TFC/Q) (AVC) = (TC/Q) / delta Q)
(TVC/Q)
6 1 65 10,000 5000 15,000 153.8 76.9 230.8

6 2 160 10,000 10,000 20,000 62.5 62.5 125.0 5,000 52.6
6 3 300 10,000 15,000 25,000 33.3 50.0 83.3 5,000 35.7
6 4 420 10,000 20,000 30,000 23.8 47.6 71.4 5,000 41.7
6 5 550 10,000 25,000 35,000 18.2 45.5 63.6 5,000 38.5
6 6 678 10,000 30,000 40,000 14.7 44.2 59.0 5,000 39.1
6 7 763 10,000 35,000 45,000 13.1 45.9 59.0 5,000 58.8
6 8 840 10,000 40,000 50,000 11.9 47.6 59.5 5,000 64.9
6 9 882 10,000 45,000 55,000 11.3 51.0 62.4 5,000 119.0
Why the Long-run Average Cost Curve is U-shaped
Long‐run average cost curves will fall when
there are economies of scale, as shown in
stage one up until Q1. There will be constant
returns to scale when the firm is experiencing
output Q1 to Q2, as shown in stage two. And,
finally, long‐run average costs will rise when
the firm is experiencing diseconomies of
scale, beyond Q2 in stage three.
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Returns to Scale – In Three Stages
Savings (economies of scale) are possible as firms progress to larger production – that is, increases in output can
result in a decrease in average cost. There are five types of scale economies.
1. Technical economies: relating to the firm’s ability to take full advantage of the capacity of its machinery.
2. Managerial economies: as firms grow, they can afford to employ – and benefit from – specialised managers.
3. Commercial economies: such as buying in bulk and advertising.
4. Financial economies: larger firms have a greater variety of sources for funds and often at favourable rates.
5. Risk bearing economies: larger firms may achieve distinct advantages by diversifying into several markets and
researching new ones.
Returns to Scale – In Three Stages
• When economies of scale are exhausted, constant returns to scale begin. Some economists regard the
commencement of this stage as the minimum efficient scale (MES) since it represents the lowest rate of
output at which long‐run average costs are minimised – and no further economies of scale can be achieved in
the present time period. The MES is represented by point Q1 in Figure.
• Clearly, economies of scale are more easily associated with standardized manufactured products. Indeed, in
many manufacturing industries a firm has to be big to survive. This is certainly not the case in construction.
• The unique nature of many construction projects, plus the relatively small size of many construction firms,
prevents the industry from realising the full potential of economies of scale
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Costs in the long-run
Long-run average cost (LAC) and long-run marginal cost curve (LMC)
When a firm is producing at

an output at which the
long-run average cost LAC
is falling, the long-run
marginal cost LMC is less
than LAC. Conversely,
when LAC is increasing,
LMC is greater than LAC.
The two curves intersect at
A, where the LAC curve
achieves its minimum.
Example
The following table gives the short‐run and long‐run total costs for various
levels of output of an organisation.:
A. Which column, TC1 or TC2, gives long‐run total costs and which gives short
run total costs? How do you know?
B. For each level of output, find the short‐run TFC, TVC, AFC, AVC, and MC.
C. At what output level would the firms short‐run and long‐run input mixes
be the same?
D. Starting from producing two units, managers decide to double production
to four units. They do this by doubling all of their inputs in the long‐run –
that is, instead of having one company produce 2 units at a cost of 400
they have essentially 2 companies producing 2 units each at cost of 400 (so
their total cost from these two companies will be 800). Comment on their
managerial skill.
E. Over what range of output do you see economies of scale? Diseconomies
of scale? Constant returns to scale?
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Solution a,b
A. TC1 gives long‐run total cost because it registers the cost
of 0 units of output as 0. In the long run, all inputs can be
varied, and the cheapest way to produce zero output is
to use zero inputs. Short‐run total costs are detailed in
column TC2. In the short run, not all inputs can be
varied, and there will be some fixed costs incurred, even
at 0 output.
B. Solution
Solution c,d
C. At 3 units and 5 units, long‐run total cost = short‐run total cost; hence, in the short run, the firm must be
producing these output levels with the same input mix.
D. Their managerial skills are deficient. They overlook the economies of scale evident from the fact that when
output doubles from 2 units to 4 units, long‐run total cost less than doubles, implying that it is not necessary
to double all inputs. Another way of saying this is that the firm is on the declining portion of the LRATC curve.
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Solution e
• The most straightforward way to answer this problem is to
compute LRATC at each output level using the total cost
figures in the column labeled TC1:
• There are economies of scale (declining LRATC) from 1 to 6
units of output, and constant returns to scale (constant
LRATC) from 6 to 7 units.
Example
The following table shows a car manufacturer’s total cost of producing cars:
a. What is this manufacturer’s fixed cost?
b. For each level of output, calculate the variable cost (VC). For each level of output except zero output, calculate the
average variable cost (AVC), average total cost (ATC), and average fixed cost (AFC). What is the minimum‐cost output?
c. For each level of output, calculate this manufacturer’s marginal cost (MC).
d. On one diagram, draw the manufacturer’s AVC, ATC, and MC curves.
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Solution
• a. The manufacturer’s fixed cost is $500,000. Even when no output is produced, the manufacturer has a cost of
$500,000.
• b. The following table shows VC, calculated as TC − FC; AVC, calculated as VC/Q; ATC, calculated as TC/Q; and
AFC, calculated as FC/Q. (Numbers are rounded.) The minimum‐cost output is 8 cars, the level at which ATC is
minimized.
Solution
c. The table also shows MC, the additional cost per additional car produced. Notice that MC is
below ATC for levels of output less than the minimum‐cost output and above ATC for levels of
output greater than the minimum‐cost output.
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Solution
• d. The AVC, ATC, and MC curves are shown in the following graph:
Problem
• A firm's total cost function is given by the equation:
TC = 4000 + 5Q + 10Q2
• Write an expression for each of the following cost concepts:
a. Total Fixed Cost
b. Average Fixed Cost
c. Total Variable Cost
d. Average Variable Cost
e. Average Total Cost
f. Marginal Cost
• Determine the quantity that minimizes average total cost. Demonstrate that the predicted
relationship between marginal cost and average cost holds.
• Explain Law of Diminishing returns
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Solution
Solution
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Question
► An electricity‐generating company confronts the following long‐run average total costs associated
with alternative plant sizes. It is currently operating at plant size G.
a. What is this firm’s minimum efficient scale?
b. If damage caused by a powerful hurricane generates a reduction in the firm’s plant size from its
current size to B, would there be a leftward or rightward movement along the firm’s long‐run average
total cost curve?
A. At point E, it is 1500
B. Leftward
Operating cost of a thermal plant
Source: Saadat 1999
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Operating cost of a thermal plant
In practice, the fuel cost of generator I can be represented as a quadratic function of real power
The derivative of the fuel cost curve versus the real power is known as the incremental fuel‐cost curve:
The incremental fuel cost curve is a measure of how costly it will
be to produce the next increment of power. The total operating
cost includes the fuel cost and the cost of labor, supplies and
maintenance. These cost are assumed to be a fixed percentage
of the fuel cost and are generally included in the incremental
fuel‐cost curve.
Source: Saadat 1999
Economic Dispatch
A cost function Ci is assumed to be known for each plant. The problem is to find the real power generation for each
plant such that the objective (i.e. total product cost) as defined by the equation below is minimum , subject to the
constraint below
Where Ct is the total production cost, ci is the production cost of ith plant, pi is the generation of ith plant, Pd is the

total load demand and ng is the total number of dispatchable generating plants.
Source: Saadat 1999
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Economic Dispatch
Source: Saadat H. 1999
Economic Dispatch
Source: Saadat 1999
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Economic Dispatch
Example
3. Market Structure
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Classification of market
Market ‐ ?
• Key components of market:
• Consumer / buyers
• Sellers
• Prices
• Commodity
Classification of market:
► Classification by area: Local, national and regional
► Classification on volume of business: Wholesale or retail
► Classification on basis of transaction: Spot and future
► Classification on the basis of competition: ??
Market structures
Type of Market
No. of sellers
Nature of
product
Entry/Exit
Control/market
power
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Four key characteristics of a perfectly competitive market
• Homogenous product: The product sold by firms in the industry is homogeneous. This means that the
product sold by each firm in the industry is a perfect substitute for the product sold by every other firm. In
other words, buyers are able to choose a product from a large number of sellers in the knowledge that it is
essentially the same. The product is thus not in any sense differentiated regardless of the source of supply.
• Freedom of entry and exit: Any firm can enter or exit the industry without serious impediments. Resources
must also be able to move in and out of the industry unimpeded; without, for example, government
legislation preventing any resource mobility.
• Large number of buyers and sellers: There must be a large number of buyers and sellers. When this is the
case, no single buyer or seller has any significant influence on price. Large numbers of buyers and sellers also
mean that they will be acting independently.
• Full information: There must be complete information available to both buyers and sellers about market
prices, product quality and cost conditions.
• Neither the buyer nor the seller has control over price – both are price takers
3 (a) Firm operating in a perfectly competitive market
Source: Dasgupta 2020
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Perfectly competitive market: supply in short run
Producer’s objective: Maximize profit
Profit = TR – TC
= TR – (TFC + TVC (Q))
= P.Q ‐ C (Q)
First Order Condition; first differential = > Zero
i.e. P=MC
Second Order condition; Second differential is negative
i.e. MC is rising
If P=P0; the firm produces Q=Q0 on the marginal cost curve ; until the shutdown point
Profit in short run
What the entrepreneur receives is called a ‘profit’
This profit is an opportunity cost – therefore a
component of cost and hence ‘normal profit’
So at equilibrium if P=MC=AC, then there is only
normal profit. This happens only a Acmin [TR=TC]
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Profit in short run
When P>AC, then the difference leads to
‘Supernormal profit’
Total revenue = OP2BQ2
Total Cost = Point where BQ2 line meet AC curve,
area of that rectangle
Profit in short run
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Profit in short run
Supernormal profit
(P2‐Ac at Q2)*Q2 (Shaded rectangular area)
Perfect competition: supply in long run
In long run, new firms can enter the market while old
firms may retire. This is unlike short run, where
number of firms are constant
Suppose existing firms earn supernormal profit at P1‐
20
This attracts new firms to enter the business. These
cost are also low, so they earn supernormal profit
As supply increases in the market, price falls below P1,
say P2.
Some firms (possible old with high maintenance cost)
will incur loss and exit market. Source: Dasgupta 2020
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Example
• A firm is operating in a perfectly competitive market. The cost of
production in the short run is given by
C(Q) = 64 +Q2
• Calculate:
a. Short –run average variable cost
b. Short‐run average variable cost
c. Short‐run marginal cost
• If the price of the product is Rs 32/
• Determine the optimum level of production
• What is the profit?
Example
C(Q) = 64 +Q2
Total fixed cost = 64; Total variable cost = Q2
Average variable cost
= TVC / Q = Q
Average fixed cost
= TFC / Q = 64/Q
Average cost = AFC + AVC = (64/Q) + Q
Marginal cost = d/dq (variable cost)
= d/dq (Q2 ) =2Q
For profit maximization, under perfectly competitive market P=MC
32=2Q; Q=16 is the optimal level of production
AC at Q=16=(64/16)+16=20<P
Since P>AC, there is supernormal profit = (P‐AC)*Q= (32‐20)*16=12*16=192
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3 (b) Firm operating in a monopoly market
Why energy market are not perfectly competitive
 Asset specificity:
Asset-specific investments have limited or no value in alternative uses’ hence, they are sunk investments
because of which a firm is likely to be willing to operate, even if prices are below total average cost.
E.g. assets deployed in power plant or investment in oil field (drilling, well service/workover rigs etc.)
 Capital intensiveness:
Capital cost (i.e. fixed cost) constitutes larger share of the total cost. As a result economies of scale is prominent
when the size of operation increases
 Mass‐ consumption:
Massive product consumption implies large consumers, and thus the set of consumers closely approximate
the set of voters (Spiller and Tommasi 2005:519).
These features create specific contracting problems and expose utilities to political interference, creating
incentives for government to behave opportunistically and expropriate rents by administrative measures,
such as lowering prices, disallowing costs, controlling purchasing or employment patterns, irrespective of
utility ownership (ibid.: 519). Thus, political capture of utilities either directly or indirectly and
redistribution of benefits among politically relevant groups of citizens remain major problems which are
the subjects of a vast literature (Crew and Kleindorfer 2002; Dal Bó 2006; Guerriero 2011; Joskow 1989).
 Indivisibility of capital
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 Investment is lumpy in nature‐ capacity
expansion takes place as per the size of the
plan unit. Example: A power plant of X MW
will comprise of n number of units each of
200‐500 MW
 Supply curve is therefore not continuous
 Unlike perfect competition the Marginal
cost is not continuous, i.e.. supplier can
continuously increase the output, but here
(monopoly) it is lumpy you can not
increase continuously
 P=MC
 If MC is not smooth then how does pricing
takes place.
200‐500 MW
 P=MC
takes place.
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200‐500 MW
 P=MC
takes place.
200‐500 MW
 P=MC
takes place.
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200‐500 MW
 P=MC
takes place.
200‐500 MW
 P=MC
takes place.
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200‐500 MW
 P=MC
takes place.
200‐500 MW
 P=MC
takes place.
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200‐500 MW
 P=MC
takes place.
200‐500 MW
 P=MC
takes place.
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200‐500 MW
 P=MC
takes place.
Natural Monopoly
What leads to natural monopoly?
 Monopoly resources: Eg. Coal, oil, diamond etc.
 Natural monopoly: “industry in which multi‐
production is more costly than production by a
monopoly”
 Happens when fixed cost is high while variable
costs are relatively small.
 Huge gestation period
 Etc.
 Under natural monopoly, AC declines as the fixed cost is so high
(while average variable cost is negligible ), thus AC is determined
by average fixed cost and it declines as production increases
 As average cost is falling then the marginal will also fall (unlike in
perfect competation where AC increase because of increasing
average variable cost)
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Pricing under Natural Monopoly
In case of natural monopoly, marginal cost pricing leads to loss.
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Pricing under Natural Monopoly: Two – part Tariff
 In case of natural monopoly, marginal cost pricing leads to loss.
 The natural monopoly will face loss under marginal cost pricing
 This loss could be recovered through a two‐part tariff

 A fixed fee of charge that can recover the average cost and
above the marginal cost
 Price per unit that is equal to the marginal cost
 However, uniform charging of the fixed fee may become
burdensome for some consumers with lower demand.
Pricing under Natural Monopoly: Two – part Tariff
 In case of natural monopoly, marginal cost pricing leads to loss.
 The natural monopoly will face loss under marginal cost pricing
 This loss could be recovered through a two‐part tariff
 A fixed fee of charge that can recover the average cost and
above the marginal cost
 Price per unit that is equal to the marginal cost
 However, uniform charging of the fixed fee may become
burdensome for some consumers with lower demand.
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Thank You
Overview
Economics of Energy Supply
Session 6: Economics of Electricity Supply (Chapter 10)
Session 7: Economics of Renewable Energy Supply (Chapter 11)
Energy Markets
Session 8: Principles of Energy Pricing (Chapter 12)
Session 9: Energy Pricing & Taxation (Chapter 13)
Reference Book: Energy Economics Concepts, Issues, Market and Governance by Bhattacharya S. C.
82
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Lecture Outline
I. Basic concepts related to electricity system

 Diversity factor
 Load curve and load duration curve
 Capacity factor
 Load factor
II. Capacity mix
III. Economic dispatch
Basic concepts related to electricity system
Diversity factor is defined as the ratio of sum of maximum customer demands in a system
to the maximum system load.
Diversity Factor = ∑ Maximum Consumer Demand
(Maximum Load of the System)
= Sum of individual maximum demands

Maximum demand of the system
The diversified the load is, the lower the peak capacity
requirement is. This reduces the investment need for the
system. The inverse of the diversity factor is called the
coincidence factor.
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The demand imposed by the consumers connected to the grid varies quite significantly within a day, within a week, by
season and from one year to another. The daily demand varies as the need for electricity use shows strong time
dependence.
The plot of demand for 24 h in a chronological order is called the daily load curve
Load Curve is the plot of demand for 24 hrs in a chronological order.
Load Curve
 Electricity demand shows significant daily and seasonal variations.
A plot showing the variation in demand met

with respect to time is known as the load curve.
If this curve is plotted over a period of time for 24
hours, it is known as daily load curve (Figure 1). If
it is plotted for a week, month or a year it is
named as weekly, monthly and yearly load curve
respectively. The load curve reflects the activity of
a population of society with respect to electrical
power consumption over a given period of time
Fig. A typical all India daily load curve (POSOCO:)
43
04‐03‐2023
Load Curve
The load curve shape peaks and leans are

determined by the major type of load in that
area.
For residential consumers, the electricity demand
peaks more in the evening when residents switch
on the lighting, cooling and heating loads.
The commercial loads tend to be higher during 8
am to 6 pm when the offices and commercial
complexes are running and lean during the night
hours.
The industrial loads tend to run continuously at
almost a steady value.
This pattern of loads can be easily visualised from
figure 11.
Source: POSOCO 2016:5
Basic concepts related to electricity system Load Curve
 Electricity demand shows significant daily and seasonal variations.
Time factor in load profile:

Daily/Weekly/Monthly Periodicity:
Weekly Periodicity: Weekdays/Weekends
Monthly Periodicity::
The daily load curve varies with changing
months/seasons.
The load curve of May (summer season) is
very different from that of December (winter
season).
The characteristic weather conditions of
different months and demand response to it has
resulted in unique daily load curve shapes
throughout the year for each month which is
repeated every year as shown in figure 7.
Source: POSOCO 2016:5
44
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Load Curve
 Importance to have a flatter load curve ? (i.e. lesser difference between the peak hrs
demand and off‐peak hr. demand)
 Contracted capacity reduction / reduction in capacity requirement
 Proper utilization of contracted capacity

LOAD DURATION CURVE
If the information of daily load curves is collected over a year, the frequency of occurrence of different loads can be
determined. A plot of such a cumulative frequency distribution by load is called the load duration curve (see Fig. 10.3).
For 100% of the time, the system load is in excess of a small amount of load, called the based load (which is found on the
right hand extreme of the curve) while for 0% of the time the system load exceeds the highest load (or the peak load).
The diagram can tell for how many hours the system experiences a load in excess of a given load. For example, the system
shown in Fig. 10.3 indicates that for about 40% of the time the system load was equal to or in excess of 1500 MW
45
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CAPACITY FACTOR
different types of plants have different capacity utilization rates, called capacity factors. The capacity factor is
defined as follows
Capacity Factor = kWh produced in a year

(Maximum Load of the System)
The base load plants could be used almost 100% of the time, while peaking plants are used only for
a very short period (usually\20% of time). If the load did not vary so widely during the year, power
plants could have been used more uniformly.
SYSTEM LOAD FACTOR (LF)
Depending on the shape and size of the three elements of the load‐duration curve, the overall
capacity utilization is determined. This is called the system load factor (LF) and is the ratio of area
under the load‐duration curve to the area of the rectangle formed by the peak load for entire
duration of the year
Load Factor = kWh consumer in a year

(Peak load * 8760)
46
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2. Capacity Mix
2. Capacity Mix: Global
 65.3% of global gross electricity production, by coal and coal
products, oil and oil products, natural gas, biofuels including
solid biomass and animal products, gas/liquids from biomass,
industrial waste and municipal waste.
 Electricity generation from combustible fuels accounted for
57.1% of total OECD gross electricity production (compared
with 71.1% for non‐OECD).
 Over the two years 2018 and 2019, global electricity generation
from renewable sources such as wind (+11.8%) and solar
(+22.5%) registered robust growth.
47
04‐03‐2023

Gross Electricity Production: OECD (1974-2020)
48
04‐03‐2023
2. Capacity Mix: India

Analysis of generation capacity added (i) ownership wise
180000
160000
140000
24% 26%
120000
Capacity (MW)
100000 State
Central
80000 Private
60000
40000
50%
20000
0
31‐Jan‐03 31 Dec. 2015 31 Dec. 2020 Fig. : Ownership wise breakup of India’s installed
capacity as on 31 July 2022 (404.3GW)
Fig. : Trend of change in the ownership of power
generation capacity over years in India
Source: Bhatt et al 2022

Analysis of generation capacity added (ii) Ownership wise
 Private participation allowed in 1991, but in terms of real capacity addition only 9,151 MW was added during 1991 to
2003. During this initial reform period private investment remained elusive due to non‐remunerative tariff structure
and financial bankruptcy of the state supply companies
 Later, there was a surge in the share of private investment, attributed to two factors: (1) Various policy initiatives
(modification in tariff contracts, moving away from negotiated contract (or memorandum of understanding) with
independent power producers to the competitive based route, dedicated policies for large scale coal generation (such
as ultra mega power plants), and recent incentives in the solar based generation. (2) Greater certainty in the
regulatory environment with initiatives like introduction of multi‐year tariff system
 Private investment fuel choice: The private sector has invested mostly in coal followed by renewable sources.
However, on December 31, 2020, private investment shifted to renewables as renewable capacity is 49% of the total
private capacity, while thermal reduced to about 43%.
 The regional concentration of private investment: As on Dec, 2015, 42% of all private power plants are located in the
western region. Gujarat has 23% of India’s private power plants, making the private share almost 58% of its capacity.
Eastern and north‐eastern regions, where power capacity additions are needed, have a share of 8% (eastern) and
0.04% (north‐eastern) in terms of private ownership. Proper incentives need to be offered to private investors in
these regions for a more balanced addition of power capacity.
49
04‐03‐2023

Analysis of generation capacity added (ii) fuel wise
250000
206124.5
RES
173017.88
28%
200000
Coal
Capacity (MW)
150000 Gas
Nuclear Thermal
91153.81
Diesel
Nuclear 2% 58%
100000 Hydro
50618.38
Hydro
45798.22
42623.42
37415.53 RES
12%
41236
26660.23
24956.51
24473.03
50000
11561.4
18307
1628.36
1162.83
993.53
509.71
6780
5780
2720
2343
1565
165
0
31‐Mar‐90 31‐Jan‐03 31 Dec. 2015 31 Dec. 2020
Fig. : Fuel wise breakup of India’s installed
Fig. : Trend of change in the fuel mix of power capacity as on July 2022 (404.3GW)
generation capacity over years in India

Thermal (coal, gas, diesel) capacity
 Coal: Beside easy availability of domestic coal (although of poor quality), the key reasons for which huge addition
of coal‐based capacity took place includes large emphasis of government via various policy measures and financial
incentives to exploit coal.
 Government’s emphases included setting up of ultra‐mega power plants; provision of competitive bidding (case I
and case II) for power procurement, etc.
 However, despite having huge reserves of coal, production of coal failed to keep pace with the demand arising
from huge coal‐based capacity build up. This led to increased use of imported coal. Use of imported coal increased
per unit cost of electricity. But the procurers of this electricity, the financially starved distribution utilities, were not
capable to buy this expensive electricity (as discussed below in Section 5.2). Besides this, generators faced
technological constraints to use imported coal beyond a certain percentage. Recently major private sector
generators have faced problems for increase in prices of imported coal (mainly due to change in law/policies of the
source country). This has resulted in litigation as the PPA do not allow pass through of increased fuel cost (CARE,
2014). All this has influenced capacity utilization and are discussed in Section 6.4
50
04‐03‐2023

 Gas and diesel based capacity: Of the total gas based generation in India, 40% is owned by private sector, 31% by
center government, and 29% by different state governments. Of the total diesel based generation in India, 55% is
owned by private sector.
o Since the KG D‐6 find, the largest gas reserve in India, significant gas‐based capacity has been added, but the
production from this source has been on decline, resulting in gas shortage to damaging proportions. Of the
total 20,381 MW gas based plants, about 14,029 MW is dependent on KG D‐6 basin gas. About 2,979 MW
capacity which runs exclusively on KG D‐6, is lying ideal. While the other is operating at a low PLF of about
25%, is stranded for want of gas as described in section 6.4.
 Nuclear: All the nuclear based generation in India is owned by central sector (none by private and state sector).
India has 20 nuclear reactors that operate with a total of 5,780 MW capacity (CEA, 2016). The 11th Five‐Year Plan
targeted an additional 3.38 GW of nuclear capacity, of which only 0.88 GW was achieved. This is due to delayed
construction of nuclear plants because of public protest and also safety audits undertaken after the Fukushima
accident. The 12th FiveYear Plan envisages increasing nuclear capacity by 2.8 GW (MoP, 2012). An additional
capacity is under construction, including two reactors in Tamil Nadu, two in Gujarat, and the remainder in
Rajasthan (DAE, 2012).

Renewable capacity
 Renewable capacity, both grid and off‐grid, increased sharply in response to government incentives such as
feed‐in‐tariffs on the generation end and renewable energy certificates that have promoted trade in renewable.
 Major share of RE capacity is owned by private sector
16,000 15,182
Installed Capacity (MW)
14,000
12,000
10,000 8,391
8,000
6,000 5,398
4,000
2,000
-
2010 2015 2020
Karnataka Tamil Nadu Gujarat Maharashtra Rajasthan
Andhra Pradesh Madhya Pradesh Telangana Punjab Uttar Pradesh
Fig.: Renewable energy installed capacity: State‐wise Source: Bhatt et al 2022
51
04‐03‐2023

Analysis of generation capacity added (iii) region wise
North‐East Islands
1% 0%
Northern
Southern
27%
30%
Western
33%
Eastern
9%

Analysis of generation capacity added (iii) region wise
The maximum capacity addition has been in the western

region. This is in contrast to the fact that most fuel reserves are
in the eastern region of the country. Maharashtra, followed by
123410.57
140000
Gujarat, are the two states with highest installed capacity. The
113460.18
regional concentration of generation capacity results in a

101615.09
100144.81
120000
greater gap between power supply and demand. The regional
100000
concentration of power capacity in a few states risks
75310.67
Northern perpetuating the uneven economic development across the

69871.63
Western country. There is a need to bringing place a well‐integrated

Capacity (MW)
80000
Eastern national grid to mitigate this imbalance
Southern
60000
North‐East
33941.53
33594.28
the largest private capacity lies in WR followed by SR. This is a

31564.02
28452.56
28451.76
Islands
40000 striking finding since private sector has mostly invested in coal
16696.68
(as found earlier), which is mostly found in ER. Still maximum

private capacity came up in WR and not in ER. This reflects the
4637.64
3513.32
2309.41
20000
75.27
59.27
51.15
preferential policies of WR states in attracting private

0 investments
31 Jan. 2003 31 Dec. 2015 31 Dec. 2020
52
04‐03‐2023
2. Capacity Utilization: India

83.00%
78.60%
77.68%
77.20%
76.80%
74.97%
74.80%
74.30%
78.00%
73.47%
72.70%
72.20%
70.13%
69.90%
73.00%
69.00%
67.30%
65.56%
64.70%
64.60%
64.25%
68.00%
64.00%
63.00%
62.24%
PLF
61.07%
61.00%
60.72%
60.00%
59.88%
63.00%
57.10%
56.50%
56.50%
55.99%
55.30%
55.00%
58.00%
53.90%
53.20%
52.40%
53.00%
48.00%
 Thermal PLF has decreased consistently over the years
 State generators face the lowest, followed by the private and central in the given order.
 Fuel wise gas‐based stations have lower PLF compared to coal‐based stations
2. Capacity Utilization: India
 Lower PLF is a loss not only to the society but also to the generators. Under the changed tariff regulations of
Central Electricity Regulatory Commission, generator’s incentives are linked to PLF, compared to the earlier
plant availability factor. So lower PLFs, have resulted in lower incentives for regulated generators. Further a
low PLF would lead to lower than benchmark operating parameters (like station heat rate and secondary
fuel consumption).
53
04‐03‐2023
3. Economic Dispatch
MERIT ORDER DISPATCH
1. Basics
2. Indian Scenario
Readings
Suggested Readings:
1. Draft National Electricity Plan 2022
2. Draft Report on Optimal Generation Capacity Mix for 2029‐30
54
04‐03‐2023
Thank You
55

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04‐03‐2023

Session 6: Economics of Electricity Supply (Chapter 10)

Session 7: Economics of Renewable Energy Supply (Chapter 11)

Session 8: Principles of Energy Pricing (Chapter 12)

Session 9: Energy Pricing & Taxation (Chapter 13)

II. Cost Functions of Firm

III. Market Structures

IV. Market and Pricing

1. Firm, theory of firm and

Nature of the firm

 A firm is an organisation that brings together different factors of production

What do firms do?

A firm’s technical representation: Production Function

Production Function: It refers to a function showing maximum output that

• General production function is expressed as:

Production in short-run versus long-run

Short-run is a period in which firms can adjust production by

Diminishing Marginal returns

196 Total Product

Q from hiring second worker

Long – run : 𝑋 𝑓 𝐿, 𝐾 Where both labour (L) and capital (K) are vary

Capital Labour input

● Returns to scale: Rate at which output increases as inputs are increased

● increasing returns to scale Situation in which output more than doubles

● constant returns to scale Situation in which output doubles when all

● decreasing returns to scale Situation in which output less than doubles

2. The cost of production

Measuring costs: which costs matter?

Variable costs: Costs that varies with the level of output

Measuring costs: which costs matter? …cont.

Fixed cost versus sunk cost versus variable cost:

Costs in the short-run: Total cost

Source: Myers 2009

Costs in the short-run: average & marginal cost

Source: Myers 2009

Average And Marginal Costs

0 30 90 130 161 196

Fixed Variable Output Average Delta Q Delta L (L2‐ Marginal

6 1 65 10,000 5000 15,000 153.8 76.9 230.8

Why the Long-run Average Cost Curve is U-shaped

Returns to Scale – In Three Stages

Returns to Scale – In Three Stages

Costs in the long-run

When a firm is producing at

Operating cost of a thermal plant

Operating cost of a thermal plant

Where Ct is the total production cost, ci is the production cost of ith plant, pi is the generation of ith plant, Pd is the

Four key characteristics of a perfectly competitive market

3 (a) Firm operating in a perfectly competitive market

Perfectly competitive market: supply in short run

Profit in short run

Profit in short run

Profit in short run

Profit in short run

Perfect competition: supply in long run

3 (b) Firm operating in a monopoly market

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive

Why energy market are not perfectly competitive