The fundamental truth of marginal and average costs

Opponents of increased distributed energy resources who advocate for centralized power distribution insist that marginal costs are substantially below retail rates–as little as 6 cents per kilowatt-hour. Yet average costs generally continue to rise. For example, a claim has been repeatedly asserted that the marginal cost of transmission in California is less than a penny a kilowatt-hour. Yet PG&Eā€™s retail transmission rate component went from 1.469 cents per kWh in 2013 to 4.787 cents in 2022. (SDG&E’s transmission rate is now 7.248 cents!) By definition, the marginal cost must be higher than 4.8 cents (and likely much higher) to increase that much.

Average costs equals the sum of marginal costs. Or inversely, marginal cost equals the incremental change in average costs when adding a unit of demand or supply. The two concepts are interlinked so that one must speak of one when speaking of the other.

The chart at the top of this post shows the relationship of marginal and average costs. Most importantly, it is not mathematically possible to have rising average costs when marginal costs are below average costs. So any assertion that transmission marginal costs are less than the average costs of transmission given that average costs are rising must be mathematically false.


2 thoughts on “The fundamental truth of marginal and average costs

  1. Pingback: Retail electricity rate reform will not solve California’s problems | Economics Outside the Cube

  2. Richard McCann Post author

    If someone insists that the marginal cost or value related to one particular aspect does not follow this pattern, e.g., costs avoided by added DERS, then they must calculate the total marginal cost and identify the components of that marginal cost that are excluded from the aspect that they’ve focused on.



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