In a series of essays, we introduce average incremental cost (AIC) pricing and present examples to help
understand its advantages. In non-convex markets, AIC pricing is the rough equivalent to marginal cost
pricing in convex markets. We present a qualitative comparison of current ISO pricing methods and the AIC
approach. We argue that AIC better meets the Federal Energy Regulatory Commission’s stated goals. We
compare incentives to deviate from efficiency-maximizing behavior for resources under current pricing
methods and AIC pricing. We present models and examples of AIC Pricing and other pricing methods in
single-period markets and compare approaches. In multi-period markets, non-convexities like startup costs,
minimum operating levels, minimum run times and minimum down times present pricing issues that are
resolved using cost causation principles. We develop the multi-period mathematical model for AIC pricing.
In networks, non-convexities address issues involving the role of flowgate marginal prices in signaling for
efficient transmission expansion. We develop the network mathematical models for AIC pricing. We discuss
the role of Price-Responsive Demand and Ramsey-Boiteux pricing needed for market efficiency. We show
that along with the LMP, the AIC is a better signal for efficient entry, but in some cases, it is too low.
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