Peak Load Pricing

There are certain non-storable goods, e.g. electricity, telephones, transport and security services etc., which are demanded in varying measures during the day as well as night. For example, consumption of electricity reaches its peak in day time. It is called ‘peak-load’ time. It reaches its bottom in the mid-night. This is call ‘off-peak’. Electricity consumption peaks in daytime because all business establishments, offices and factories come into operation. Electricity consumption decreases during nights because most business establishments are closed and household consumption falls to its basic minimum. In terai, demand for electricity peaks during summer season due to use of fans, ACs and coolers, and it declines to its minimum level during winters. Similarly, consumption of telephone services is at its peak at day time and at its bottom at nights. During Dashain festival, the demand for bus and air travel services rises to its peak in Nepal.

A technical feature of such products is that they cannot be stored. Therefore, their production has to be increased in order to meet the ‘peak-load’ demand and reduced to ‘off-peak’ level when demand decreases. The excess production in ‘off-peak’ period could be stored and supplied during the ‘peak-load’ period. But this cannot be done. Besides, given the installed capacity their production can be increased but at an increasing marginal cost (MC).

Pricing of goods like electricity is problematic. The nature of the problem in a short-run setting is depicted in the figure. The ‘peak-load’ and ‘off-load’ demand curves are shown by Dp and DL curves, respectively. The short-run supply curve is given by the short-run marginal cost curve, SMC. The problem is ‘how to price electricity’.

Peak-Load Pricing of Electricity
As shown in figure, if electricity price is fixed in accordance with peak-load demand OP3 will be the price and if it is fixed according to off-load demand, price will be OP1. If a ‘peak-load’ price (OP3) is charged uniformly in all seasons, it will be unfair because consumers will be charged for what they do not consume. Besides, it may affect business activities adversely. If electricity production is a public monopoly, the government may not find it advisable to charge a uniform ‘peak-load’ price.

On the other hand, if a uniform ‘off-load’ price (OP1) is charged, production will fall to OQ2 and there will be acute shortage of electricity during peak hours. It leads to ‘breakdowns’ and ‘load-shedding’ during the peak-load periods, which disrupt production and make life miserable. This is a regular feature in terai, the capital city of Nepal. This is because electricity rates in terai are said to be one of the lowest in the country.

Alternatively, if an average of the two prices, say P2 is charged, it will have the demerits of both ‘peak-load’ and ‘off-load’ prices. There will be an excess production to the extent of AB during the ‘off-load’ period, which will go waste as it cannot be stored. If production is restricted to OQ1, price P2 will be unfair. And, during the ‘peak-load’ period, there will be a shortage to the extent of BC, which can be produced only at an extra marginal cost of CD.

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