The Peak Load and Off Load Problem an analysis
Download as PPTX, PDF0 likes37 views
The Peak Load Pricing is the pricing strategy wherein the high price is charged for the goods and services during times when their demand is at peak. In other words, the high price charged during the high demand period is called as the peak load pricing.
The Peak Load and Off Load Problem an analysis
- 1. The Peak Load and Off Load Problem VAIBHAVVERMA01744@GMAIL.COM
- 2. Brief Outline: Public Utility Types of Public Utility Monitoring a public utility Problem Peak Load and Off Load Pricing Merits Demerits Peak Load Pricing: Welfare Implications
- 3. What is a public utility A public utility is a company that operates as a public-service corporation, and provides essential services to the public such as electricity, telephone service, natural gas, water or postal services. The public utility is typically regulated by the national, state or local government. The term ‘public utility’ may also refer to the service or product itself – water, natural gas, sewage, etc. – that these organizations supply to members of the public. A public utility often forms part of a natural monopoly. A natural monopoly is a monopoly that exists because a specific market’s economies of scale make it the most cost-effective way to provide consumers with the best quality and price.
- 5. Monitoring a public utility The government agency limits how much the public utility can charge consumers, and may insist that even those who cannot afford to pay the market price are still supplied – this is called a universal service obligation. Left to itself in a natural monopoly environment, a private-sector public utility would make decisions that are most profitable for the business. Such decisions would lead to high prices and the minimum of service compared to competitive conditions. These decisions might not be in the best interests of society. State agencies that monitor public utilities aim to make sure these services are economically accessible to most or all of the population. When a public utility is state-owned, the government usually creates autonomous bodies to protect them from day-to-day political interference. In the majority of cases, state-owned public utilities tend to be less efficient than their counterparts in the private sector.
- 6. Presenting the Problem Consider goods for which demand fluctuates cyclically over time, both daily and seasonally. Electricity or gas demand peaks in the morning, at noon and in the evening, and is highest in winter. Local bus and underground services are used most intensively between 7 and 9 a.m. and 4 to 7 p.m. Air and rail traffic have a holiday demand peak; telecommunication has a business demand peak. In all these cases it is impossible to use off-peak production to serve peak demand because the goods are not storable, at least not at reasonable costs. The supply side of such goods also has special features. The production typically is characterized by high fixed costs and low variable costs; there are many cases of increasing returns to scale. In other words, the characteristics of 'natural monopolies' are often present: enterprises producing those goods could keep others out of the market by their pricing policy and still make profits. For these reasons the goods are produced either by nationalized or by regulated public utilities.
- 7. In practice such public utilities are often required to meet all demand, however high it may be. (There are some theoretical arguments to justify this requirement.) A public utility which charges only one price for its output will therefore face a trade-off between fairly high capacity costs and a fairly high price. To cope with this trade-off, profit-maximizing as well as welfare maximizing monopolies have used systems of price differentiation. The simplest rule of thumb in our peak-load case is based upon the distinction between operating and capacity costs: only consumers who are responsible for the capacity costs should pay for them. Hence peak demand pays operating plus capacity costs whereas off-peak demand pays the low operating costs only. This price structure is designed to encourage a more uniform utilization of capacity by reducing peak demand and increasing off peak demand. Welfare gains result from the fact that consumers are not driven from the market completely, but rather are enticed to shift their demand from peak to off-peak times.
- 8. Peak Load and Off Load Pricing The Peak Load Pricing is the pricing strategy wherein the high price is charged for the goods and services during times when their demand is at peak. In other words, the high price charged during the high demand period is called as the peak load pricing. The peak load pricing is widely used in the case of non-storable goods such as electricity, transport, telephone, security services, etc. These are the goods which cannot be stored and hence their production is required to be increased to meet the increased demand. Thus, the marginal cost is also high during the peak periods as the capacity to produce these goods is limited. For example, during summers, the electricity consumption is highest during the daytime as several offices and educational institutes are operational during the day time, called as a peak-load time. While the electricity consumption is lowest during the night as all the office establishments and educational institutes are closed by this time, called as off-peak time.
- 9. Peak Load & Off Load Pricing MC is also high during these peak periods because of capacity constraints. Prices should, thus, be higher during peak periods as Fig. 9.13 shows, where D1 is the demand curve for the peak period, and D2 is the demand curve for non-peak period. The firm sets MC = MR for each period, such that price P1 is high for the peak period, and the price P2 is lower for the off-peak period, with corresponding quantities Q1 and Q2. This increases the firm’s profit above what it would be if it charged one price for all periods. It is also efficient; the sum of producer and consumer’s surplus is greater because prices are closer to MC.
- 10. Merits I. Peak load pricing would help balance capacity usage. II. Reducing growth in peak load. III. Decreasing the need for capacity expansion, through charging customers in peak time a higher peak price. IV. Shifting part of the load from the peak to the base load plants which called valley filling and charging off peak customer a lower off peak price, thus having some savings in used fuels during peak time.
- 11. Demerits 1. The investment cost of installing time-sensitive measuring equipment. The new technology may entail switching costs. Producers may also have to hire field personnel and supervisors 2. Introducing PLP has some costs that need to be taken into consideration and must be weighed against the welfare gains of more efficient pricing. PLP requires sophisticated measurement of customer usage and advanced metering. Many utilities may lack information that allows differential pricing across periods of consumption and would therefore need to upgrade metering equipment so as to introduce PLP. 3. The drawback of this theory is that it abstracts from a more general behavior in which at least some consumers may choose to shift their demand from one season to another in response to a lower price during their “less desirable” season. 4. False prediction leads to wrong pricing regulation
- 12. What, then, is the reason for developing a special theory of peak-load pricing? First, the government does not want too many prices because this leads to high information and administrative costs and to uncertainty for consumers. Second, the government wants to avoid high peak prices, mainly because of distributional considerations. High peak prices for local transport may disadvantage the lower-income working population most and not the more affluent car owner Third, the government wants to meet all demand because reliability is an important quality characteristic of public supply.
- 13. Peak Load Pricing: Welfare Implications • Suppose you charge all consumers the same price, p* instead of P1 & P2 • At the lower price of p* peak users will want to consume Q3 but the facility can only produce Q1 , so their consumption remains at Q1 but they are better off because they pay a lower price. • no implication for welfare because its just a transfer from firms to peak users.
- 14. Peak Load Pricing: Welfare Implications • For the off peak users, they would consume less at p*, quantity falls from Q2 to Q4 . • They will be worse off: • Loss of benefits: Q4 AB Q2 • Resource Savings: Q4 CB Q2 • Welfare loss: ABC • Adjusting for fact that off-peak consumption is W2 of total welfare loss is W2 *ABC
- 15. Conclusion • With peak load pricing consumers at every stage of the demand cycle pay the marginal cost of their consumption. • If price uniformly across the cycle (i.e., charge the same price at all points in the cycle) you get a welfare loss. • Also results in under producing facility