Peak-load Pricing
Charging more when it costs more to produce
A common form of price discrimination 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 include 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 which only
operate at such times).
The reason for the higher prices charged at peak times is partly to do with elasticity of
demand. Demand is less elastic at peak times. For example, many commuters have little
option but to pay higher rail fares at peak times.
But the higher charges are often also 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: stations 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.
£
MC
Ppeak
Poff peak
b
a
ARpeak
MRoff peak
ARoff peak
MRpeak
O
Qoff peak
Qpeak
Peak-period and off-peak-period pricing
Units per hour
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?