Abstract
This paper deals with the simultaneous determination of welfare-optimal pricing and investment rules under a multi-period ex ante maximum demand charge by allowing the possibility of purchasing electricity from third party generators at some cost when excess demand occurs. I show that at the optimal size of capacity, expected short-run marginal shortage cost and long-run marginal capacity cost should be equal. The optimal maximum demand tariff does not entail marginal cost pricing. In general, it is shown that maximum demand charges are welfare superior to marginal cost pricing when tariffs must be set ex ante, before demand is known.
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