Price discrimination and the peak load problem

Abstract

The pricing policy of a public utility that faces a demand which varies cyclically is examined with respect to its welfare effects. The conventional first best, marginal cost pricing principle is assumed to have prohibitive administrative costs. Two second best alternatives - a "maximum demand tariff" and "price discrimination according to demand peakiness" are examined for their optimality with regard to maximising producers ' and consumers' surplus. The optimal maximum demand tariff is shown to yield more total welfare and to be a Pareto improvement on the ohter.