Peak-Load Pricing and Short-Run Marginal Cost

Abstract

The conventional wisdom of peak-load pricing (following Williamson, 1966, see for example Rees, I976, p. 69), is: (i) Thefirm peak case. The off-peak price equals marginal variable cost or shortrun marginal cost (SRMC), and the peak price equals SRMC+ MCC/a (where MCC = marginal capacity cost and a is the length of the peak period) if off-peak demand at SRMC does not exceed peak demand at SRMC + MCC/a; (ii) The shifting peak case. Prices are set to equate peak and off-peak demand, and consumers in both periods contribute towards capacity costs if off-peak demand at SRMC exceeds peak demand at SRAIIC + MCC/a. This conventional argument is based on a model in which demand at each price is constant throughout the peak period, and constant at a lower level throughout the off-peak period. There is a discontinuity in demand at each price at the start and end of the peak period. A general analysis of the more realistic case in which demand at each price varies continuously over time, but in which there can be only a finite number of price changes, is given in Craven (I 97 ). The purpose of this note is to draw out a conclusion from that model which was not made explicit in that paper, and which has important implications for the conclusions of conventional theory quoted above. The result (propositions i and 3) is that