Capacity Constrained Peak Load Pricing

Abstract

The traditional theory of peak load pricing focuses on normative rules for pricing a public utility's nonstorable service whose demand is periodic. The analysis of capacity investment is relatively simple in these models because of the following assumptions: (a) capacity is constrained to be greater than or equal to demand; (b) a single equipment type is used to provide service; and (c) demand does not vary within given price periods. Thus, when prices are chosen optimally, optimal capacity is simply equal to demand in the peak period. The optimal capacity investment rules do not appear to be so obvious, however, if assumptions (b) and (c) are generalized somewhat. A very realistic assumption, especially for electricity generation, is that several equipment types are used to produce the public utility's service (output). Moreover, an examination of the empirical data on public utility demands reveals that the traditional assumption of intraperiod time invariant demand is untenable. Indeed, these empirical results show that it is more realistic to assume that public utility demands, in given price periods, depend on both price and time-of-day. The peak-load pricing and capacity decision problem is examined under (b) and (c). Further assumptions are: the traditional capacity constraint ismore » invoked; the various equipment types have different cost characteristics; marginal capital and operating costs are constant for all equipment types; there is no uncertainty on either the demand or supply side; there is no secular growth in demand; the demand in period does not depend on the prices; and there are no price periods.« less