1. A small Midwestern municipal utility serves 70,000 residential customers (no commercial or industrial customers) and buys all of its power either directly from other companies through long-term contracts or through the wholesale market. It has a long-term contract for a fixed quantity of relatively low-cost nuclear for which it pays $0.6/kWh. That is not enough to fulfill the needs of its customers, however, so it buys additional power it needs on the wholesale market where the price is $0.08/kWh. It has calculated that the overall average cost of power it procures is $0.065/kWh.

The utility also has fixed costs of distributing power and billing (which it incurs regardless of how much power consumers buy in a given month). It has figured out that its fixed costs are $1 million per month (including a fair rate of return on its investment) and it sells an average of about 20 million kWh per month, so it can cover its fixed costs with an additional charge of $0.05 per kWh (1 million/20 million kWh) .

So, to cover all of its costs, the utility is currently charging $0.115/kWh (=$0.065+$0.050)

1. Is the utilitys pricing policy creating deadweight loss (i.e. reducing total surplus or overall economic value)? Explain why or why not.
2. Suggest a two-part tariff that would minimize deadweight loss. Please provide a specific number and your calculation for each part of the tariff.