Case F5
Peak-load Pricing
Charging more when it costs more to produce
A common form of price discrimination1 is peak-load pricing. This is where people are
charged more at times of peak demand and less at off-peak times. Take the case of a holiday.
If you look through the brochures, you will see that high-season prices are often considerably
higher than low-season prices. Similarly, call charges for telephones are much higher during
weekdays than in the evenings and weekends. Other examples of peak-load (or ‘peak-period’)
pricing are rail and air fares, prices in cinemas and restaurants (higher in the evenings),
charges made by health and sports clubs (higher at weekends and in the evenings) and
electricity prices (lower prices at off-peak times to those with special meters that only operate
at such times).
The reason for the higher prices charged at peak times has partly to do with elasticity of
demand (and in this sense, therefore, is price discrimination: i.e. charging different prices
because of different demand elasticities in different parts of the market). Demand is less
elastic at peak times. For example, many commuters have little option but to pay higher rail
fares at peak times.
£
MC
Ppeak
Poff peak
b
a
MRoff peak
ARoff peak
ARpeak
MRpeak
O
Qoff peak
Qpeak
Units per hour
Peak-period and off-peak-period pricing
But often the higher charges also have to do with higher marginal costs incurred at peak
times. With various fixed factors (such as plant and equipment), marginal costs are likely to
rise as output expands to meet higher demand. This could be due to diminishing returns to the
variable factors; or it could be due to having to use additional equipment with higher
operating costs.
Take the case of electricity. At off-peak times, the power stations with the lowest
operating costs will be used. These are normally the nuclear and coal-fired stations. At
periods of peak demand, however, the stations with higher operating costs will have to be
brought on line, such as oil- and gas-fired stations. (Gas-fired stations are relatively cheap to
build, but have higher running costs.) As a result, the marginal cost of generating electricity is
higher at peak times than at off-peak times.
But what are the profit-maximising peak and off-peak prices? These are illustrated in the
diagram, which shows units per hour (e.g. of electricity). There are two demand (AR) curves
– peak and off peak – and their corresponding marginal revenue (MR) curves. Profit is
maximised in either period at the output where MR = MC (points a and b respectively). In the
peak period, this will be at the higher price Ppeak. There are two reasons why the price is
higher. First, demand is less elastic. This is demonstrated by the fact that price is a higher
percentage above MR in the peak period than in the off-peak period. Second, marginal cost is
higher in the peak period.
Questions
1. If, over time, consumers are encouraged to switch their consumption to off-peak periods,
what will happen to peak and off-peak prices?
2. To what extent is peak-load pricing in the interests of consumers?
3. Is total consumption likely to be higher or lower with a system of peak and off-peak
prices as opposed to a uniform price at all times?
1
Strictly speaking, price discrimination is where different prices are charged in different parts of the market as a
result of different price elasticities of demand: the higher price being charged in the part of the market with the
lower price elasticity. Where differing prices, as in this case study, are partly also the result of differing costs,
then this is not pure price discrimination.
2