Some Simple Analytics of Peak-Load Pricing

Abstract

We consider a public utility that provides its service at two different times. Capacity in place can be used in both periods. We study the effects of a change from uniform pricing throughout the day to peak-load pricing, when the utility is constrained to operate with a fixed rate of return on capital. The conventional wisdom seems to be that with peak-load pricing, the peak price will be higher and the off-peak price lower than under uniform pricing, and that peak-load pricing leads to a lower installed capacity. These effects are not generally true. There are plausible cases in which introducing peak-load pricing reduces the price of the service both in peak and off-peak times. Furthermore, peak-load pricing can lead either to greater or to smaller capacity than uniform pricing. We are able to find simple expressions that determine the size and direction of each of these effects. We also provide a criterion for determining whether a particular individual gains or loses from peak-load pricing.