(a) Cost allocation mechanisms are important when it comes to establishing other aspects of inter-firm compensations and how these are transferred to the users. There are two principles: receiving party pays (RPP) and calling party pays (CPP). Although from a theoretical point of view RPP seems to have better characteristics for ensuring allocative efficiency, CPP has been the overwhelming success in relaated to worldwide diffusion. Compare CPP with RPP.
(b) Long Run Incremental Cost (LRIC) is an economic cost concept designed to encourage:
- use of existing facilities where desirable; and
- investment in new facilities where justified.
List the strengths and weaknesses of the three approaches to LRIC modeling.