The effect of output specification on the optimal policy design for electric utilities

We show that the manner in which the production process is seen when analyzing data on electricity production has an impact on the policy conclusions. In particular, we show that the different specifications of output found in the literature can generate quite diverse views regarding regulation and optimal industry structure, even when using the same data to estimate a cost function. To illustrate this we use information gathered from the Spanish Electric Industry and analyze electricity activities following three approaches: the traditional aggregate activity view, the multistage model and the multioutput-multistage approach. We estimate the degree of economies of scale S and derive marginal costs for all models, plus economies of vertical integration (EVI) for the last two ones. Then we compare these results and verify that the aggregate analysis can mislead policymaking.