Steiner 1957 Paek Loads and Eficient Pricing

Peak Loads and Efficient Pricing
Author(s): Peter O. Steiner

Source: The Quarterly Journal of Economics , Nov., 1957, Vol. 71, No. 4 (Nov., 1957), pp.
585-610
Published by: Oxford University Press
Stable URL: https://www.jstor.org/stable/1885712
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PEAK LOADS AND EFFICIENT PRICING*
By PETER 0. STEINER
Introduction, 585. - I. Solution of the two period peak load problem under
simplifying assumptions, 587.-II. Relation of the solution to some earlier con-
tributions, 592. - III. Can purely cost-based prices be used to achieve optimal
results?, 596. - IV. Some policy implications, 602.- Mathematical Appendix,
604.
One of the most pervasive problems affecting the regulated

industries is the problem of capacity cost. From an economic stand-
point the problem is to find an appropriate price policy that leads to
the correct amount of physical capacity and its efficient utilization,
and that also covers the full social costs of the resources used. The
problem arises, classically, in either of two situations: the case of
declining costs, where prices at or near marginal costs imply prices
below average costs, and the case of peak loads and the resulting
partial underutilization of the total capacity available. It is with
the peak load problem, defined more fully below, that this paper is
concerned, and to focus on this problem we assume throughout that
operating costs are a linear function of output, and that the cost of
capacity is a linear function of the number of units of capacity built.'
In fact, of course, the peak load problem may easily occur in com-
bination with the problem of declining costs.
The phenomenon of peak loads is characteristically found where
the product or service is technologically not storable as in services
generally and as with electric power and transportation, both inter-
and intra-urban; or where the alternative storage costs are high
owing to the bulk or other properties of the products, as in the case
of pipe line transportation of petroleum.
* I gratefully acknowledge the assistance of the Social Science Research
Council whose Faculty Research Fellowship made this paper possible. Jack
Hirshleifer, Hendrik Houthakker, and Carl Christ raised illuminating objections
to an earlier draft. Roger Miller made numerous improvements in the argument.
My major debt is to Robert Dorfman whose help at every stage was enormous
and whose improvement of the Appendix beggars description. Opinions and
errors are my own.
1. The separate linearity of these two classes of cost (and the consequent
constancy of the elements of marginal cost) does not mean that total marginal
cost is constant; indeed, it is the variability that is the crux of the problem we
treat. Even with this simplification the problem is complex. It should be noted
that it is only where average and marginal costs are equal that identification of
marginal cost pricing with precise covering of total costs is possible.
585

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586 QUARTERLY JOURNAL OF ECONOMICS
Particularly with respect to electric power there is a long his-

tory of disucssion of this problem' and a recent revival of this dis-
cussion by economists3. As Houthakker suggests "the vast litera-
ture on electricity tariffs shows so many different views that it would
be difficult to be original in proposing tariff changes." But, by the
same token, if an optimal solution can be rigorously identified, not
all of the various suggestions can be valid. The nonoptimality of
various engineering proposals has been adequately demonstrated by
the recent literature, but the adequacy of more recent contributions
has not been so critically examined. It will appear that Lewis
recognizes the correct solution, but perhaps because he merely asserts
it, or perhaps because he did not choose to develop its implications,
more recent writers (Houthakker and Davidson, in particular) after
recognizing his priority appear to be led astray. Davidson explicitly,
and Houthakker implicitly are led to the incorrect conclusion that
an optimal pricing scheme necessarily lies, not in some scheme of
discriminatory pricing,4 but in a sophisticated application of mar-
ginal cost pricing.
A primary purpose of this paper is to demonstrate the nature
of the theoretical solution to the peak load problem. This is done
rigorously and with some generality in the Appendix, but some treat-
ment of the problem is also given for a simplified case in Section I.
It will appear that the optimal prices may require price discrimina-
tion. Section II will examine the Houthakker and Davidson solu-
tions. Section III will show an interpretation of cost based (i.e.,
nondiscriminatory) prices that will- uniformly permit an optimal
solution, but it will appear that this is an unusual, if intriguing,
interpretation. But even given this interpretation, we will show
that the optimal solution will be reached only under restricted con-
2. This literature goes back at least to the famous 1892 paper by John
Hopkinson. For reviews of these contributions see P. Schiller, Methods of Allo-
cating to Classes of Consumers or Load the Demand Related Portion of the Standing
Cost of Electricity Supply, Technical Report K/T 106, British Electrical and
Allied Industries Research Association, 1943; and Ralph K. Davidson, Price
Discrimination in Selling Gas and Electricity (Baltimore, 1955).
3. I date this new discussion from the paper by W. ArthurLewis, "The
Two-Part Tariff," Economica, VIII, N. S. (Aug. 1941). This paper is expanded
in Lewis' Overhead Cost (New York, 1949). See also, H. S. Houthakker, "Elec-
tricity Tariffs in Theory and Practice", The Economic Journal, LXi(Mar. 1951),
1-25; I .M. D. Little, The Price of Fuel (Oxford, 1953); and Davidson, op. cit.
There is, of course, a long history of theoretical discussion of the problems of
overhead cost to which the peak load problem is related.
4. We shall use Davidson's definition of price discrimination: "a seller
practices price discrimination if the relative prices he charges for the various
units of his . .. products are disproportionate to the relative costs of produc-
tion of the units sold." Davidson, op. cit. p. 23.

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PEAK LOADS AND EFFICIENT PRICING 587
ditions. The paper concludes with some brief comments on impli-

cations for public policy.
Consider the following simplified problem: suppose a product

is to be produced in two time periods of equal length (say, day and
night) and to incur only two kinds Qf costs. Let b be operating costs
per unit per period, assumed constant. Let 3 be the cost of provid-
ing a unit of capacity, which is assumed independent of the amount
of capacity required. From the long-run (planning) point of view
the marginal cost of a unit of output is thus b if there is excess capac-
ity and b + f. if it requires new capacity. Assume that there is a
known demand curve for output in each period, each demand curve
being a declining function of the quantity of product in that period
alone. Assume further that the two demand curves are not identi-
cal, are independent of each other, and that the demand curve for
output in the first period lies everywhere above that in the second
period.' We wish to determine the optimal output in each period,
and the prices that will lead buyers to purchase these quantities. The
amount of capacity that is required is the maximum output in either
period -- that is, the maximum (or peak) demand on the system.
A peak load problem will be said to exist at any price, if the
quantities demanded in the two periods at that price are unequal.
The social goal implicit in the usual identification of marginal
cost pricing with optimal results is the maximization of the excess
of expressed consumer satisfaction over the cost of resources devoted
to production,' and we adopt it here. The private objective is taken
to be the maximization of the excess of satisfaction over the prices
that must be paid. The problem is to specify a set of prices which
will lead buyers to purchase the quantity of output in each period
that will lead to the social optimum.
Were it not for the fact that the quantity demanded is a func-
5. A number of these limitations are for expository convenience only and
do not affect the results. The Appendix treats the problem more generally,
assuming n periods, and placing no restriction on the demand relations other
than that they are continuous and declining.
6. The social objective is thus the maximization of the sum of the consumers'
and producers' surpluses. This requires the output where the demand curve is
cut from below by the marginal cost curve. The private (buyers) objective is
the maximization of consumers surplus. Taken together these conditions imply
p = mc. Where the cost curve- is in horizontal sections (our case) the problem
is particularly simple since producers surplus is zero (total costs equal total
revenues) when p = me. For the further conclusion of optimal resource alloca-
tion it is usually, but not universally, argued that price and marginal cost be
equal in all sectors of the economy.

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tion of the prices charged for output in each period there would be
neither difficulty nor interest in the peak load problem. No difficulty
because charging P1 = b + j3 and P2 = b would recover total costs,
would assure that all units sold were paying the full marginal costs
of their production, and would assure that no unproduced unit was
capable of paying such costs. But if the demands were perfectly
inelastic, there would be no effect on output of any change in prices
and thus one scheme of prices would be equivalent to any other so
far as impact on resource use is concerned.7
FIGUJRE I
P P
--'t 3 ---
DI DC \
Pt=b b I
xi . xx . , X: Xxx,.......x
x~t
Xe
FIRM PEAK CASE SHIFTING PEAK CASE
Figure I will illustrate the problem. The curves D1 and D2 are

the demand curves for output in the separate periods from which
the operating costs have been subtracted. They are, thus, the effec-
tive demands for capacity. (It will be recalled that our problem
consists in determining the amount of capacity ab initio). The curve
De is the vertical sum of the positive portions of PDi and D2, and
can be interpreted as the total effective demand- for capacity.8 Each
of the cases pictured is by our definition a peak load problem.
7. The linkage between quantities and prices is what chiefly distinguishes
the recent economic literature from the earlier discussions. Practically it requires
attention to anticipated quantities rather than to quantities observed in the
past under a different structure of prices.
8. Demands are added vertically because the demands of the separate
periods upon capacity are complementary not competitive. This is the trick. A
similar procedure is appropriate in the case of public goods in the theory of public

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Consider the left hand ("firm peak") case. The tot

capacity is l,, (where the demand for capacity equal
cost of providing the capacity), and since the marginal capacity
demand is that of users in period 1 only, the appropriate price for
period 1 is P1 = b + 3. This capacity would be justified even if
there were no demand in period 2. Hence period 2 users should be
permitted to purchase output (or service) as long as they cover the
operating costs of producing that service. The appropriate quantity
is x2} and P2 = b. In this case the marginal cost prices,
P1 = b + d (marginal cost including cost of marginalcapacity),
P2 = b (marginal operating cost),
are fully satisfactory. No unproduced unit of output can cov
costs of production, nor does any produced unit fail to do so.
prices while different in the two periods are nondiscriminator
based wholly on differences in costs.
Application o? these same "cost based" prices to the right
"shifting peak," diagram leads to quantities xl and x2 which a
satisfactory. Notice that xl is less than x2. The off-peak pric
charged to units which in fact make the peak demand upon ca
Capacity cost of only xl units are recovered, but x2 units of c
are required. Nor would an "average price" (call it P), P =
b + f3/2 (equal in the diagram to f3/2 because b is taken as the zer
axis) be satisfactory. For the resulting outputs (x , x2) would requir
x4 units of capacity and pay for only (x4 + x2)/2 units; the margin
units of capacity would not be justified by demand for that capacit
(see Do); nor, given the capacity 4*, is it fully utilized in period 2
To see the correct solution examine the DC curve. A total
amount of capacity equal to x, is justified by the combined demands.
Given this capacity the outputs in each period should be extended
to this capacity since in each case they exceed the operating costs,
b. The optimal quantities -x = xl = x2 require the prices P1 and
P2 shown in the figure.
To generalize the argument it is essential to recognize that a
unit of capacity is justified if and only if (1) it is justified by the
demand in any period alone, or (2) it is justified by the combined
demands in two or more periods. Once the appropriate capacity is
determined, output in each period should be extended to that capac-
ity unless additional units of output fail to cover the operating costs
expenditure. See Paul A. Samuelson. "Diagrammatic Exposition of A Theory
of Public Expenditure," Review of Economics and Statistics, XXXVII (Nov. 1955).
In the vertical addition, attention is restricted to the positive portions
of the demands for capacity since ineffective demand (i.e., demand that will not
even cover operating costs) is totally irrelevant to the decision.

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at an earlier output. Then given the optimal outputs in each period

and the demand curves, it is routine to determine the optimal prices.
The essential feature of the solution to the two period, shifting
peak case is that the optimal quantities are equal and the prices
unequal. For pedagogic reasons we may write the required prices
in terms of a deviation from the average prices as:
Pi = b + 0/2 + k
P2 =b + 0/2 + k,
where, since the sum of the prices is 2b + i3, k, + k2 0. If the

demand curves are different at No, the prices are unequal and since
this is truly a case of joint costs, unequal prices in the face of equal
outputs and joint costs mean discriminatory prices.9
These results are easily generalized to more than two periods,
which may be mixed in the sense that among some subgroup of
periods shifting peak relationships apply, yet between this group
and the others a firm peak prevails. Figure II illustrates a three
period case of this sort. Results for an n period case are given in
the Appendix, equation (6).1
The essence of this solution is the same as for the two period
case. The total capacity cost is borne by the periods which make
the peak demand upon the capacity, and whose demands collectively
justify the marginal unit of capacity. But the capacity charge
among these periods is unequal; it is proportional to the strength of
the effective demands for capacity. Fundamentally this charge is
thus allocated according to demand, and is discriminatory. Output,
among these periods, is equal notwithstanding differences in demand.
9. That this is discrimination within the definition used has been questioned
by two critics. Hirshleifer suggests that a true representation of marginal cost
would have it be a horizontal line (at b) until S, and then rise vertically; in this
view the optimal prices are equal to marginal cost (albeit on the vertical section).
But, in my view, this neglects the fundamental discontinuity in the marginal
cost function of a peak load problem, which leaves marginal cost undefined at
xo. Further, since we are concerned with a planning cost curve the use of a
demand-determined optimal capacity as if it were a "fixed cost" seems wholly
unjustified.
Professor Chamberlin suggests that since periods one and two are sepa-
rate, the "products" are different and thus the notion of discrimination loses
meaning. This view has substantial merit, but it leads away from the meaning
generally given to discrimination in this area, and in others. Indeed it virtually
annihilates the concept of discrimination.
1. The generalized argument of the Appendix not only coversthe "n" period
case, but makes no use of the assumption of noncrossing demand curves, and
also considers the case of demand curves that are interdependent. The essen-
tials of the simplified two period case are unchanged.

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For all other periods output is extended until such point as price
equals b, the marginal operating costs.
The nature of the demand curves may occasion comment. It
may be argued that responses to price changes are likely to be slow
and lagged and thus that use of an instantaneous demand relation-
ship may be misleading. It is common for writers in this field to
view the problem of demand response as a series of shifts in short-
run demand curves in response to a change in prices. Supposing
this to be appropriate we should regard the demand curves as drawn
FIGURE II
Dc
e- 3 D
D2~~x
xR X X
X~t
THREE PERIOD, MIXED CASE
as being long-run curves embodying the relevant points of a series

of instantaneous demand curves, as illustrated in Figure III.
Concerning the significance of the shifting peak case one can
not go far on a priori reasoning, but two comments seem worth mak-
ing. Since the ratio of peak to off-peak marginal costs may be
large - estimates of the ratio in both England and Baltimore for
electric power are of the order of 7:12. i can certainly not be dis-
missed as trivial without evidence. Further, the restriction of the
example to a two period case makes the shifting peak case seem less
plausible than in fact it should. Should there be, say a dozen or
2. See Houthakker op. cit. pp. 22-23; and Davidson op. cit. p. 194.

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twenty-four periods (e.g., hours), the relations of the dem

some few of these may well partake of the shifting pe
even though some subgroup of periods may be a firm p
FIGURE III
D: Da D, D
XI
DEMAND FOR X1
the others. It seems not unreasonable that the relevance of shift-

ing peaks may often lie within a broad peak interval.8
II
The solution to the peak load problem case presented above

provides a framework for discussion of alternative solutions, theo-
retical and practical. The solution here, of course, is purely theo-
retical, since it assumes detailed knowledge of the anticipated demand
behavior as well as of the nature of costs. The impracticability of a
solution resting upon data that would be difficult to come by will be
dealt with subsequently. For the moment we digress polemically.
Without exception the able economists who have dealt with
this problem have arrived at the correct solution to the firm peak
case. With respect to the shifting peak case it is only the proof and
implications of the solution given above that claim attention. The
solution was succinctly (perhaps overly so) stated by Lewis in 1941
in this sentence: "If there is a good demand for both commodities
it is impossible to allocate cost between them; demand alone will
3. A peak interval is defined as some group of consecutive periods among
which shifting peak relationships occur. I have assumed throughout that the
periods occur in a recurring cycle and that the full cycle takes a fairly short
interval (e.g., days, or months). Roger Miller has called my attention to the
fact that if there is a significant time interval between time zero and the first
peak, and if there is a carrying cost of capital, the amount of optimal capacity
takes on a dynamic aspect. One must then also consider the right time path of
capacity construction, and an interim pattern of short-run utilization. This is
a good point, but I will continue to neglect it for simplicity.

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decide which part is to be contributed by each."'4 More recent

writers have been more explicit but less successful.
Houthakker, in 1951, provided an illuminating discussion of
the shifting peak case. In essence his scheme introduced the time-
of-day tariff in this form: charge "energy cost" (b in our notation)
prices for all periods whose rate of consumption in these periods
will not (at this price) exceed the demand in the peak periods;5
the remaining periods are charged a price which adds to the energy
charge the per unit share of the total capacity cost. By this device
total capacity costs are always recovered and, as he notes, to achieve
this separation of energy and capacity costs "two rates appear to
be sufficient"-.8 His argument is not limited to the two period case;
the need for only two rates is due to the fact that the group of pe-
riods not receiving the low rate all share the capacity cost on an equal
per unit basis. For the two period, shifting peak case Houthakker's
rates would be (call them R1, R2; other notation unchanged):
Xi+
R, =R2 b + b: = + d
X1+X2 !e2
1XI-
Since x2 < x1 (by definition), the rate for each period is greater than
b + 0/2 and too little is consumed in period 2, as output is curtailed
short of capacity and before energy costs equal price. The peak
price (and thus the amount of capacity required) may be high, low
or correct depending upon essentially irrelevant considerations.
These prices will thus tend to underutilize the capacity built whether
or not they lead to the correct amount of capacity.
Houthakker's own illustration (his figure 4) reduces to a three
period case similar to our Figure II. Period 1 is the peak, period 2
is a "potential peak" (if charged the off-peak rate its demand would
exceed that in period 1) and period 3 is clearly off-peak. The prices
he recommends are:
4. Economica, op. cit. p. 251. The expanded version of this paper leaves
little doubt that Lewis saw the correct solution as far as the producer's optimum
is concerned. He appears to rely upon competitive pressure to force prices down
to the level of marginal costs. For regulated (and, presumably, insufficiently
competitive) industries public policy must assume the role of the competitive
force.
5. This is my interpretation of his statement (p. 16) that "the- low-rate
periods were defined by the condition that their maximum demand was equal
to the maximum demand in the high-rate periods."
6. Houthakker op. cit. pp. 15-17.
7. See the Mathematical Appendix, problem 2.

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Ri = R2 = b +
X 2
1 +-
Xi
R3= b.
where, as drawn, x2 < X3 < xi at these prices. Thus period 3 uses

more capacity but pays for less than does period 2. As we have seen,
the optimal requirement among peak and potential peak periods is
equal outputs and unequal prices, not the reverse.
Davidson, in 1955, appears to regard the firm peak case as the
basic one, but discusses the shifting peak case explicitly. His solu-
tion amounts, in the end, to the same one as Houthakker's, but the
exposition has an interesting dynamic element. Letting R1, R2 now
stand for prices in his two period scheme, but otherwise using the
same notation as before, his basic prices are:
- Ri = b + ,
R2= b.
If the off-peak quantity threatens to eclipse the peak quantity, t

off-peak rate should be increased by an amount (call it a) sufficient
to keep the quantity demanded below the peak level. The resulting
excess of revenues over off-peak marginal cost should be reflected
in a decrease in the peak price. That is:
aX2
R2= b+ a;-R,= b+8-
XI
How large should a be? This is uncertain, but the limit to a is

reached when R1 = R2.8 Davidson clearly intends an iterative pro-
cedure whereby a is gradually changed in response to lagged demand
responses until an equilibrium is reached. Designating xl and x2?
as the equilibrium quantities it is unclear whether at equilibrium
xl? > x2 and R1 = R2 or whether x4 = x2 and R1 > R2.9 It
8. Cf. Davidson, op. cit. pp. 120-23, 194-95.
9. It is unclear for two reasons. First because it is impossible to be sure
what Davidson intends since his several verbal formulations say quite different
things. Second because the dynamics of the iterative process involved presents
problems. Each will be considered briefly.
The most important reason for supposing that Davidson believes the
equilibrium to occur at RI = R2 is his stress on the nondiscriminatory nature of
the proposed prices. The pricing scheme he proposes is at the heart of his non-
discriminatory scheme which he argues is clearly superior to systems of dis-
crimination. But consider also: "Rates for such hours where a new peak devel-
oped should be raised sufficiently to flatten out the peak and keep the quantity
demanded below the annual peak level." (p. 194) "If the rate of consumption

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seems most likely that Davidson regards R, = R2 as implying

= x2, but of course it does not if the demand curves are sepa-
rated, as they must be if there is a problem to discuss. Supposing
the equilibrium to be reached when R, = 1R2 (for reasons just indi-
cated in note 9), the results are identical to those of the Houthakker
scheme' and subject to the same limitations.
Can these schemes, which are nonoptimal, be justified in terms
of their practicability? Houthakker's proposal clearly requires some
demand information (to determine which are the peaks and the
potential peaks, and also to permit accurate estimation of the per
unit capacity charge), but perhaps less than full knowledge of the
demand curves is required. Davidson's iterative scheme has a prac-
tical appeal and might be feasible if appropriately modified. A proper
during U (off peak period) continues to threaten to exceed the peak rate of con-
sumption during T (peak period), the price charged for energy consumed during
U should continue to be increased and the rate for energy consumed during T
decreased until the point is reached where the rate per unit of energy consumed
during both periods is equal." (p. 122)
But, despite all of the above, I may misinterpret him. If so, and if an
equilibrium is reached where x1 = x2, the results while discriminatory are opti-
mal. But will such an equilibrium be reached?
Suppose a uniform price system is replaced by the prices R,= b +,B
R2= b in a two period, shifting peak situation where the initial quantity sold
in the first period exceeds that in the second, but where the equilibrium quan-
tities at the new prices will be greater in period 2 than in period 1. Now change
prices gradually following Davidson's formula. Eventually as a is increased,
R1 will equal R2. But what happens to quantities? In the absence of any fur-
ther change in prices, x1 will fall and X2 rise, but the effect of the price changes
will be to inhibit both of these changes, quite possibly stopping them short of
equality. It is not possible to say whether this iteration will lead to equal quan-
tities before the limiting price equality is reached without knowing a good deal
about the dynamics of the lagged demand responses and the elasticities of both
long-run demand curves.
There is a further dynamic problem: should prices be gradually changed
in response to every shift in the quantities xl, x2? If so, even clearly off-peak
periods will have prices raised above the optimal level of marginal operating
cost, b; if not, when does one start the process?
1. Since R1 = R2,
b +a = b + , a2
Xl
x2
and therefore Davidson's b + a is identical with Houthakker's
b+-
X1

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gradual procedure would be to start from equal price

and increase P1 and decrease P2 until the quantities were equalized.
Of course, if equal price changes are used the total cost of capacity
used would not be covered during the transition period. A modified
Davidson criterion of unequal price adjustments might avoid the
insufficient cost recovery but this requires at least some ex ante
demand information.2
III
Knowing only costs (b and () can a pricing system be devised
that will lead to the optimal results? It should be possible since,
when prices are equated with marginal costs private and social costs
become identical, and the objective in each case is to maximize the
excess of consumer satisfaction (expressed in the demand relation-
ships) over costs. A simple cost based scheme (P1 = b + 3; P2 = b)
failed because the prices appropriate to peak and off-peak periods
were assigned to-specific periods in advance, and buyers chose to
purchase quantities at those prices that led to a different defacto
peak. These perverse results in the shifting peak case result from
buyers taking advantage of the rigidity of ex ante labeling of peak
and off-peak rather than from any fundamental divergence of private
and social optima.
Suppose, however, the following pricing scheme was announced:
peak price = b + A3/m,
off-peak price =b,
where m is the number of periods with the maximum demand. These
prices would be assessed at the end of the accounting period,3 based
upon actual consumption. The essence of this scheme is to deter-
mine the peak ex post rather than estimating it ex ante. Leaving
aside, for the moment, the practicability of such a scheme it would
have several advantages:
1. It would require the price-fixing authority to pay attention
to nothing but costs, and recorded consumption.
2. When speaking of cost recovery, it is evident that the most that can be
achieved is cost of capacity actually used, including, of course, any standby capac-
ity required for continuity of service in the face of repairs. Whether a solution
(such as this one) that would leave some previously built capacity idle, deserves
to be called optimal, is debatable. If secular growth in the demand for capacity
is anticipated, or if resources are reasonably free to exit and the durability of
capacity is fairly short, a revision of the pricing system looking toward an opti-
mal pricing scheme seems clearly worthwhile. Under other conditions the prob-
lem should be modified to consist of optimal utilization of existing capacity,
the cost of which is irrelevant.
3. Which is longer than a full cycle of periods within which demands vary.
For daily variations, the accounting period might be a month.

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2. It would always recover the full cost of resources used (under

the assumption of constant costs). This is so because the peak price
always recovers the cost of capacity for the units paying the peak
price, and by definition the period(s) of maximum demand pay this
price.
3. It would never require more than two prices for any account-
ing period, notwithstanding m greater than 1.
But would it lead to optimal outputs and optimal capacity?
Possibly, but not necessarily. It would if buyers chose to maximize
their collective welfare. Consider a two period case in which there is
a single buyer, who has different demands for output in each period.
Under the pricing scheme suggested he cannot avoid paying for any
capacity used, and so (if he is assumed to be a maximizer) will (in
effect) purchase capacity if it adds more to his satisfactions than to
costs. The argument of Figure I applies directly to him and he will
examine the combined demand for capacity of both periods as well
as the demand of either. Regarding the shifting peak case of Fig-
ure I he chooses the quantities x1 =x2 = Xo, because the combined
demand for capacity justifies this capacity, and no more. But hav-
ing purchased this capacity it should be fully utilized. The fact
that the monopsonist under this scheme pays an "average" price,
b + A/2 is of no consequence. At those prices he would of course like
to buy more in period 1 and less in period 2, but he cannot do so
without raising the price (to b + ,3) for all units of period 1. This,
as is evident, is unwise since it requires him to pay for more capacity
than he wants. In like manner a group of individual buyers acting
in concert, explicit or implicit, might be expected (given profit shar-
ing) to achieve the same (optimal) result.
But consider the behavior of two buyers, each having demands
in both periods, with collusion or communication effectively pro-
hibited. They will not necessarily reach the optimal position for
two reasons. First, because under this pricing scheme the marginal
cost of capacity to a single buyer may differ from the social marginal
cost, and second, because while the combined marginal units of the
different buyers may collectively justify a unit of capacity, the
individual marginal unit of neither may justify it, and the collective
opportunity is thus foregone. Each of these points may be simply
illustrated.
To see the first (and probably less important), suppose that two
buyers A and B, are purchasing the quantities shown in the follow-
ing table:

34.192.2.131 on Tue, 28 Sep 2021 21:22:45 UTC
Period
1 2
Purchasers
A 1 9
B 9 1
Total 10 10
Under the proposed pricing scheme, each is liable to a capacity

charge of 5j3.4 If A considers adding one additional unit in period 2,
that period will become the sole peak, and his capacity cost will
increase to 10f3, resulting in a marginal capacity cost for the addi-
tional unit of 5f. Even if the valuation of the tenth unit exceeded
b + Ad it might not be profitable to purchase it.5
More important perhaps is the problem of underbuilding of
capacity that may result from the wide difference between b and i8
and the nonco-ordination of different buyers' demands. Suppose
b= 1, 3 = 6 and the following are the valuations placed upon the
marginal unpurchased units by the two buyers:
A B
in Period in Period
Unit 1 2
1 6 5
2 5 4
3 4 3
4 3 2
4. By "capacity charge" is meant the excess of the total amount paid

under the pricing system over b(xl + X2), the total operating cost.
5. In a similar vein one might argue that in this example A could profitably
buy one more unit in period 1, and thereby reduce his capacity charge from 5,
to 2j8 or, alternatively reduce by one his purchase in period 2 and thereby reduce
his capacity charge to is. But either of these changes would impinge directly
upon B, and he could reverse their effect by a parallel move. That is, even with
communication forbidden one would expect duoposonists to make some recogni-
tion of their interdependence. (A more general discussion is pursued below.)
Given reasonable respect for B's ability to protect himself, A would be unwise
to act using a ceteris paribus assumption for B's behavior, in a case where B is
so vulnerable. But the inhibiting effect on output expansion discussed in the
text remains, since B would have no incentive to offset such action.

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Assuming further that periods 1 and 2 are, at the moment, co-peaks,

and that the valuations placed on additional units by A in period 2
and by B in period 1 are ineffective (below b), neither will purchase
any additional units since the marginal valuations are below the
marginal cost (= 7). Yet acting together each could profitably add
two units if the other did. What is missed (see the shifting peak
case in Figure I) is the output to the right of xl which will be the
more substantial as the time patterns of preferences of different pur-
chasers are different. But it is precisely such diversified demands
that offer the challenge to pricing in peak load situations.
Considerations of this sort immediately suggest the kind of
interdependence that characterizes duopoly and oligopoly theory,
and also the more recent theory of games. By these pricing rules
we have thus converted a quantity-adjusting situation in which all
buyers are independent to one of interdependence in which A must
take cognizance of B's behavior. Whether this is advantageous
depends upon whether we can thereby achieve the optimal results.
If we regard a game theory payoff matrix as nothing more than
a convenient way of summarizing the alternative consequences of
one "player's" actions in an interdependent situation, our problem
can be instructively treated in this form. The game, however, is
nonzero sum, and in the present formulation is a nonco-operative one.
TABLE I
HYPOTHETICAL PAYOFF MATRIXES OF NONZERO SUM GAME
A's Payoff B's Payoff Combined Payoff
B, B2 B3 Bi B2 B3 B1 B2 B8
A1 1 7 -5 Al 1 0 -5 Al 2 7 -10
A2 0 2 12 A2 7 2 3 A2 7 4 15
A3 -5 3 8 A3 -5 12 8 Aa -10 15 16
Table I presents hypothetical values of the "payoffs" to A and

B in a situation in which each is supposed to have a choice of only
three strategies, each of which corresponds to some combination of
(marginal) units purchased in each period.6 By the payoff is meant
6. This limitation on the available strategies is for convenience. It is,
however, not so limiting as might be supposed, for maximum and minimum
purchases of each "player" are determined solely by reference to his own demand
relationships. He will always buy an additional unit in both periods if the sum
of his own valuations therefor is 2b + fl; he will generally (but see pp. 597, 5

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the marginal change in the individual's "welfare" of the indicated

strategy pair.
Let us define the combination of strategies that maximizes the
combined payoff as the "optimal point" which corresponds to the mean-
ing given that term earlier in this paper under the proposed pricing
scheme. In the present example the optimal point, AMB3, corre-
sponds to A choosing row 3, and B choosing column 3. But in the
absences of co-operation or coalition is this result likely? The prob-
able outcome will be a function of the information available to each,
his view of the market mechanism, his view of the other player's
possible and probable reactions, and, further, any particular struc-
ture that may be given to the "game" by permitted or prohibited
rules of conduct. The interested reader can explore the possibilities.
The conclusion will be that nothing short of full recognition of inter-
dependence and mutual striving for joint maximization will (in
general) lead to the optimal point.7
buy an additional unit in either period if its valuation is b + i3; and he will never
purchase a unit if its valuation is below b. All that is at issue are the units that
are possibly justified only by the joint demands of both "players." In addition,
the cost uncertainty faced by A is a function of the difference between his pur-
chases in the two periods, not their level, which limits the number of alternatives
whose payoffs are a function of the game that he must consider. Finally mixed
strategies can be interpreted as linear interpolations between listed pure strate-
gies, and if the net benefits of a player can be viewed as a series of linear seg-
ments, it is necessary only to consider the corners as available pure strategies.
7. It is impractical, even in a note, to survey all possibilities, but some of
the alternative possibilities are as follows:
As a formal problem in nonzero sum, noncooperative game theory this
matrix presents no difficulties. The central notion, due to Nash, ("Non Co-
operative Games", Annals of Mathematics, Vol. 54, Sept. 1951) is that of an
equilibrium point, defined to be a point such that no unilateral change in strategy
by either player can improve his payoff. In this case there is a unique equilibrium
point, A1B1. While the payoff to each player is positive, compared with the
optimal combination, (and even with several of the nonoptimal combinations
of strategies), it is poor indeed. Yet it is possible to imagine a situation in which
this, relatively unprofitable, set of strategies might be used. Suppose each player
to be a shortsighted maximizer, who given any strategy by the other player
chooses to maximize his payoff assuming no change in the other's strategy. If
we permit recontracting, the resting place would be the equilibrium point. This
psychology is analogous to that underlying the Cournot, Bertrand, and Edge-
worth duopoly analyses, and also that of the quantity-adjusting pure competitor.
But here, also, there is no necessary reason to accept that outcome as the only
admissible one.
Suppose, given full knowledge of the matrixes, B is a mere quantity
adjuster, but A is prepared to look at the consequences of his own actions although
he recognizes that B will not. Looking at B's payoffs he sees that B will choose
strategy B1 if A selects either A, or A2, and B2 in response to As. The most
favorable of these combinations to A is the combination AsB2 with a payoff of
"3". This is preferable (in-terms of payoff to each player) to the equilibrium
point solution and we shall designate it as a quasi-equilibrium point for A. This

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This discussion of the game matrix of Table I is relevant to the

suggested ex post pricing plan because precisely this type of payoff
situation develops in the region where marginal units of capacity
are justified by demand for outputs in different periods of different
buyers. The critical conclusion is that this pricing scheme, which
alone might lead to optimal results using cost-based prices, in fact
will do so only if the individuals -can somehow be persuaded to pur-
sue collective maximization. Competitive reactions here, as else-
where, may have adverse effects on resource allocation. It is unlikely
that joint maximization will generally prevail, but it is not impos-
sible that the rules of regulatory agencies could be used to structure
individual choices toward that end. If, without foreknowledge of
demand by the price setter, competitive reactions of individual
buyers are to lead to optimal results under a peak load situation it
requires the kind of prices suggested and some mechanism for struc-
turing individual choice to pursue collective goals. This is not
impossible; neither is it easy.
outcome is analogous to the Stackelberg leadership solution in which A is the

leader, and B the follower. It may also resemble the kind of price leadership
associated with a dominant firm in an industry with a competitive fringe, in
which the large seller maximizes his profits while granting his competitors the
share of the market they choose as quantity adjusters. There is, of course, a
quasi-equilibrium for B, which may or may not differ from A's. If it coincides,
the quasi-equilibrium points are also equilibrium points, but even then it need
not be an optimal point. Returning to A's quasi-equilibrium, A could assure
this result without any co-operation or negotiation with B simply by announcing
or contracting to follow strategy As.
The purely game-theoretic features of this problem occasion these paren-
thetic comments: That the equilibrium point is not the optimal point is perhaps
not surprising. That the optimal point can occur in a dominated strategy seems
more damaging. (In the example the third strategies of each player are domin-
ated by a linear combination of the first two.) Even more damaging (to game
theory as a source of help) is the fact that points, designated as "quasi-equilib-
rium points" are superior to the equilibrium point in payoff to each player, yet
can be reached without any co-operation whatever. Yet these points may well
occur in dominated strategies and thus be eliminated from consideration if the
usual game theory procedures of solution are adopted.
Other outcomes can be enumerated. For example, suppose that each
player knows only his own payoff matrix and fears taking losses. An outcome
in which he chose his second strategy might result, as the second strategies are
alone lossproof. A similar result might occur with full knowledge of the matrixes
if each player imputed irrationality or vindictiveness to the other. (This is
maximin behavior, which is generally irrelevant in a nonconstant sum game.
Note, finally, that to reach the optimal point, mere recognition of inter-
dependence by both players may not suffice. For example, A may hope to bluff
B into B's quasi-equilibrium if he (A) can gain a higher payoff there than at the
optimal point. And similarly for B.

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IV
Identification of theoretical optima is hardly sufficient license

for policy prescription. Whether it is even necessary is perhaps
debatable. But if such optima are used - and economists in this
field (as elsewhere) have shown little diffidence - they had best be
right. This paper has attempted to show the nature of the optimal
solution to the peak load pricing problem (under some restrictive
assumptions) and further to explore the conditions under which a
purely cost-based (and therefore minimum information) policy would
and would not succeed.
Perhaps the most direct interest in the optimal solution given
lies in areas where allocation of resources is of direct administrative
concern. For example the problem of design and operation of multi-
purpose water resource programs is replete with peak load problems
some of which are of almost precisely the form of our problem, others
of which involve similar reasoning but modified formulation of the
problem.8 But in most regulated industries resource allocation is
the indirect result of the pricing scheme employed. It is this that
has accounted for the long literature on this problem which was
cited earlier in notes 2 and 3, page 586.
There is an almost total absence of empirical evidence as to the
importance of the potential shifting peak case in the areas where
peak loads are a problem. This is partly a matter of definition (th
more broadly the peak period is defined, the less shifting there will
be) but more basically a matter of empirical fact. Speculation is
possible. One would expect, for example, that demand for subway
service (and other intra-urban transportation) would be relatively
firm peaked, but Vickrey in his study of the New York subway fare
problem refuses to assert as much.9 With respect to electric power,
8. I have been priveleged to meet during' 1956-57 with the Water Resources
Planning and Development Project, Graduate School of Public Administration,
Harvard University. A chief lesson of this experience is that the problems
encountered, both theoretical and practical, are vastly more complex than meet
the eye. At this point I therefore merely suggest one potential application of
this theoretical solution. Some of the most challenging problems in the water
resource'field arise from the complementarity (with respect to use of capacity)
of different outputs whose valuations are central to efficient project design and
operation. Given variable demands (over time) for different outputs (e.g., elec-
tric power, irrigation, water supply, flood control) a peak load problem arises
in which the additional units of (storage) capacity may be justified by several
of the uses. There are, of course, other complications: to mention just one, some
uses are partially or wholly competitive with one another. A fuller discussion is
beyond the scope of the present paper.
9. Vickrey, "A Proposal For Revising New York's Subway Fare Structure,"
Journal of the Operations Research Society of America, Vol. 3 (Feb. 1955), pp.

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because of the wide difference between peak and off-peak marginal

costs, the problem seems potentially important at least within
broadly designated peak periods. In a case like pipe line transporta-
tion, where an alternative of storage is available, if expensive, large
price differences would almost certainly be significant. But many
factors, most importantly the impact on total costs of given changes
in cost of specific input prices, and the cost and availability of alter-
natives (if any) are relevant.
Supposing that the problem is important, and that optimal
resource allocation is worth striving for, and that freedom of choice
is to be given at least some role in achieving it, attention must be
devoted to schemes that are conceivable within the limits of data
attainable and that are administratively and dynamically feasible.
Inherently possible is a pricing policy that is based upon an
iterative, trial-and-error procedure. Its feasibility would depend not
only upon lagged demand responses but also upon the willingness to
change price frequently, and to admit of multiple and discrimina-
tory prices. It seems likely that considerations of administrative
feasibility and equity (which Lewis aptly characterizes as "the
mother of confusion") would be interposed.
An alternative scheme of ex post prices would certainly have
limited practical appeal because of the burden of uncertainty placed
upon buyers. But it might properly be used in a case where purchas-
ers were few in number and large in size. The often made sugges-
tion for common carrier operation of pipe lines would create a peak
pricing problem, and the use of ex post prices as a device to encourage
advance scheduling negotiations is conceivable. But the essential
requirement is co-ordination of capacity use, and competition here
works badly. It is our central conviction that conscious co-ordina-
tion, effectively circumscribed, is essential to satisfactory settlement
of the problem.
Cookenboo's suggested solution to the oil pipe line problem, the
compulsory joint venture, which he favors largely for ideological
reasons, takes on added merit when viewed in this way.' It pro-
vides almost precisely the kind of incentives for joint cost minimi-
zation that are likely to lead to optimal capacity, and efficient use
of that capacity.
38-68 (reprinted in McCloskey and Copinger, Operations Research for Manage-

ment, Vol. II, 1956). While himself proposing a time-of-day fare, he limits him-
self to estimating the responsiveness of demand to a change in the uniform rate
of fare. Recognizing the other problem he says "indeed there is no direct evi-
dence as to how great such a shift (induced by a differential rate structure) would
be." (Journal, p. 54)
1. See Leslie Cookenboo Jr., Crude Oil Pipelines (Cambridge, Maw., 1955).

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Concerning the electrical utilities, the area where the peak pric-
ing problem is most often raised, the problem of securing conscious
co-ordination, is more, difficult. Particularly for domestic users,
who are numerous and small, some clearly announced price struc-
ture is essential, and the consequences in terms of their responses to
it must be taken as the foundation for other demands. But these
users are probably relatively unshiftable in any case, and, if their
demands are firm peaked, they are subject to adequate handling
under a price structure of relatively simple form. Some co-ordina-
tion of the demands of industrial users might be achieved by advance
contracting for basic loads, at advantageous rates if complementary
to expected domestic requirements; and a system of surcharges, per-
haps applied ex post, for additional demands. This is not the place
to propose a detailed pricing scheme. The problem is more complex
than the recent literature suggests, and may be left to another
occasion.
PETER 0. STEINER.
UNIVERSITY OF WISCONSIN
MATHEMATICAL APPENDIX
Definitions:
Let x1, x2, . . . xi . . x.n be quantities of output in periods
, 2 . .. i . . . n xi, 0foralli.
Let P1, P2, . . .-Pi . .. Pn be market prices for these
Let f1(xi), f2(x2), . . . fi(xi) . .. fn(xn) be valuations of
ginal units in the respective periods. Assume fi(xi) is con
differentiable and f'(xi) < 0 for all i.
Let b be the constant operating cost per unit x per period.
b > 0.
Let if be the constant cost of a unit of capacity ,3 > 0.
Let F (xi) = fifi(xi)dxi

Let the social net benefit function, Z
n n
Z = YFi(xi) - boxi - 3 max (xi),
i
i = 1,2, ... n,
and let buyers, given prices, choose to maximize
n n
Y = TFj(xj) - ZPjxi.

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Problem la. To find the vector P = P1, P2,. . P .

will lead to x = 4x2 ... .j . . . . .nfor which Z is a loc
(Demand curves independent.)
Without loss of generality we can assume the x's have been
numbered in such a way that
x1 = X2 = . ..m > Xm+j . n,
where m is some integer in the range 1,2 . .. n.
Letxi= j+ a~t, t 'O,0 i = 12 ... n.
Since Z(Qx) is a local maximum,
dZ
dt0 0 for all values of a, .. an;
t=0
i.e.,
dZnn
-t t fj(Ja - b2a - max (as) K 0.
dt
t=o
To deduce more specific necessary conditions, apply a number of

special values of a,, . . . an.
For notational convenience let fi = fj(x) for all i.
First, let ai 1, i = 1,2 2 ... m; ai = 02i m + 12 . . . n;
then
dZ
dZ| = f -mb-f3 % .
dt
t=0
Zf -m #Ko
Second, let as = -1, i = 1,2 ... m; ai = 0, i = m + 1, .. .n;
then
dZ In
dt
dt=
|fj - - + mb +
From these two we deduce the necessary con
m
(1) 2f0(-) = mb + 13
where o = xi, i = 1,2 ... m.
Third, let ai = 0 except for some j > m and aj = 1 [assume
m < n] then
dZ _
dt f-bo

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Fourth, let ai = 0 except for some j > m and
dZ -fj + b + O.
From these two we deduce the necessary condition,
(2) f(i) = b
for all j greater than m.
Fifth, let i= O except
dZ fj-b- 0
dt t=0
Sixth, let a= 0 except for some j <s m, a; = 1. Then,
dZ - f. + b < 0.
dt t=0
From these two we deduce the necessary condition,
(3) b K, f (io) <, b + 0 j = 1y2 . .. m.

Equations (1), (2), (3) are necessary conditions to m
To see that they are also sufficient, suppose they hold
without loss of generality, that
a, > ay, j-=2, . . . m. Let k = m + 1, . . n.

If m > 1:
dZ m m
It = at(m
dt o2 2 2
t-O
n n
+ 2 akfk - b 2 ak
=+1 m+1
= 2 (a, a) (b -fj) + 7, ak;(fk;- b) <, 0)

m=a2
m n. a(m
2 2 2 +I
m n n
2 M+1
since the se
If m = 1:

34.192.2.131 on Tue, 28 Sep 2021 21:22:45 UTC
dZ Et = al(f- b - ) + Zak(fk- b) = 0.
dt t02
In either case, the conditions are sufficient to a maximum or hori-
zontal Z. But
dt t t o z i af' < 0 for all values of ai

t=0
unless a = 0, all i. Therefore the necessary conditions are sufficie

to a local maximum.
These results will become clearer with a further consideration of
m. Since we assume f '(x,) < 0, all i, it follows from
i(_ < .F
xi 0), i=m+1,...n and
fi (xi = b) i = m + 1, . .. n,
that (O) < b, i = m+1, .. .n.
Thus m is the number of functions fi(xi) such that
- fi(YO) > b. Where Yo is max (ah) and x maxim
i
i=1,2 ... n
This interpretation of m permits a concise statemen
ditions under which -To 0 exists and is unique.
Let m(x) be the number of functions of fi(xi) such
Let gi(xi) = fE(xt) - b.
Let mno be the number of functions of gj(0) for
Let m* be the number of functions of g(x*) for wh
where MO, M* = 0,1, ... n; x* > 0.
Then, to ) 0 exists and- is unique if, for some x*
mo ma
(4) 2 MO(0) > 1 > 2 g9i(x*)
my)
since 2 gi(x) is continuous and gt(xi) < 0, all i.
m
Thus, 2 gi(YO) = a}
0 (<O $ x*.
m
And Z fi(Xo) = mb + 1.
If the left side of the inequality (4) is violated, zero output is indi
cated. If the right side is violated for every x*, there is no rationa
limit to output in the m, periods.

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Having found the maximizing quantities, x, we inquire what

prices are necessary to lead buyers to choose these quantities. Si
buyers, given prices, choose to maximize Y, it is necessary that
- = 0 for all i;
axi
'ay
But a = fi(xs)-Pi = 0, and therefore that
(5) Pi= f(xi) for all i.

Thus the desired P = P1, P2, .. . Pn, where Pi =
X = X1, X2 ... Yn maximize Z, is
r Pi=b, i=m+ ,...n,

(6) m
|Pi = mb + 3, where xi = T,, i = 1, ... m
b K, -Pi K, b + ,P, i <m
which solves the problem.
For purposes of exposition in the text it prove
express Pi, i < m as deviations from the average pr
periods, b + ,8/m, as:
Pi =b + 13/m + ki i = 1,...m,
where
ki fi(-O) - (b + A/m) i =1,...m
and
m
Zki = 0.
i=1
We note in passing that, in general, as many as m + 1 diff

may be required.
The firm peak case in the text corresponds to m = 1.
The shifting peak case in the text corresponds to n 3 m > 1.
Problem lb. Relaxation of the assumption of independence of
the demand curves.
Let fi = fi(X1, X2, . . . Xi. . . x"), all i.
[i
Let F =JXfidi
_t l OF. OF OF fi +
j=1 0Xi 0Xi GOxj

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and proceed with the proof precisely as before. The FE replace fi in

every case, and the necessary conditions for maximizing Z become:
(1*) 2F,=mb+,
(2*) F;= b j > m
(3*) b F;' b + j < m
(5*) Fs= Pi all i.
Thus the required P are formally
symmetrically in (1*-3*) and (5*). Indirectly, of course, the demand
functions are effective in determining m and, in the specific
Pi = b + A/m + ki, ki. It should be noted, however, that the
conditions may not be sufficient since F.' may be positive for som
if the demand relationships are complementary.
Problem 2. To compare the capacity required in the Houthakker-
Davidson (hereafter, HD) scheme with the optimal capacity.
Let R1, R2, xl, x2 be the HD equilibrium prices and quantities
where Ri = R2 and x2 < x1.
Let Pi, P2, X12 X2 be the optimal prices and quantities, where
P2 < Pi and -x = x2.
If the two schemes lead to the same capacity it will be because
they have the same peak outputs. That is, because x1 = xl, which
implies R1 = Pi. The definitions of R1 and P1 (see the text pp. 590,
593) are as follows:
R = b + X,, P1 = b + + /2 + ki.
x12
Let x2 be the value of x2 that would make R1 = P1. We now

determine the conditions under which x2 = x2.
Since the pricing schemes under discussion precisely recover the
total costs of production - both operating and capacity, and since
when, as assumed, Pi = R1, the capacity costs are equal, we c
equate the revenues available to meet the capacity costs of the HD
scheme with those of the optimal prices,
Ri(x' + x) - b(x' + x2) = Plyl + P2x2 - b(Yi + x2),

from which P1-b X
P2 - b X2
Thus whether the capacity under the HD pricing scheme is optimal

depends upon whether x2 takes the value x*. Figure IV illustrates

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that this is determined by the shape of the upper tail of t

curve in period 2, in a region removed from the optimal
to be consumed in period 2. If x2 <d x2 then R1 , P1. Wh
,d ---------
R,= P1 I. I~DI DC
RI~~~~~~~~~~
FIGURE IV
required capacity is greater or smaller depends upon the di

inequality and also upon the elasticity of the horizont
demand curves in the neighborhood of Pi.

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Peak Loads and Efficient Pricing

Author(s): Peter O. Steiner

Stable URL: https://www.jstor.org/stable/1885712

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One of the most pervasive problems affecting the regulated

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Particularly with respect to electric power there is a long his-

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ditions. The paper concludes with some brief comments on impli-

Consider the following simplified problem: suppose a product

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FIRM PEAK CASE SHIFTING PEAK CASE

Figure I will illustrate the problem. The curves D1 and D2 are

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Consider the left hand ("firm peak") case. The tot

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at an earlier output. Then given the optimal outputs in each period

where, since the sum of the prices is 2b + i3, k, + k2 0. If the

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THREE PERIOD, MIXED CASE

as being long-run curves embodying the relevant points of a series

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twenty-four periods (e.g., hours), the relations of the dem

the others. It seems not unreasonable that the relevance of shift-

The solution to the peak load problem case presented above

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decide which part is to be contributed by each."'4 More recent

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where, as drawn, x2 < X3 < xi at these prices. Thus period 3 uses

If the off-peak quantity threatens to eclipse the peak quantity, t

How large should a be? This is uncertain, but the limit to a is

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seems most likely that Davidson regards R, = R2 as implying

and therefore Davidson's b + a is identical with Houthakker's

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gradual procedure would be to start from equal price

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2. It would always recover the full cost of resources used (under

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Under the proposed pricing scheme, each is liable to a capacity

4. By "capacity charge" is meant the excess of the total amount paid

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Assuming further that periods 1 and 2 are, at the moment, co-peaks,

HYPOTHETICAL PAYOFF MATRIXES OF NONZERO SUM GAME

A's Payoff B's Payoff Combined Payoff

Table I presents hypothetical values of the "payoffs" to A and

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the marginal change in the individual's "welfare" of the indicated

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This discussion of the game matrix of Table I is relevant to the

outcome is analogous to the Stackelberg leadership solution in which A is the

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Identification of theoretical optima is hardly sufficient license

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because of the wide difference between peak and off-peak marginal

38-68 (reprinted in McCloskey and Copinger, Operations Research for Manage-

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Let F (xi) = fifi(xi)dxi