Peak-Load Pricing

Author(s): M. Boiteux
Source: The Journal of Business , Apr., 1960, Vol. 33, No. 2 (Apr., 1960), pp. 157-179
Published by: The University of Chicago Press

Stable URL: https://www.jstor.org/stable/2351015

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 PEAK-LOAD PRICING

M. BOITEUX*

[EDITORIAL NOTE.-This article has been translated by H. W. Izzard, with some

and additions by the author, from an article in French which appeared in the Revue gbrale de
l'Plectricite in August, 1949.t This first article, which was followed by other studies,: was largely
the basis of the new price policy of Electricite de France; we therefore thought it interesting to
bring the article to the knowledge of our readers at a time when the French electricity network is
beginning to reap the benefit of this attempt to rationalize electricity rates (see the article by
Thomas Marschak in this issue).]

T H~E theory of marginal cost pricing
can be interpreted in many ways.
Selling at marginal cost means fix-
ing a price equivalent to the cost of
producing one additional unit. This cost
obviously differs according to whether
it is planned to produce the extra unit
once only or to raise by one unit the flow
of goods which was turned out before.
Production of one additional unit only
once would not justify making any
changes in plant; on the other hand, a
definite increase in the production flow
might be inseparable from the adapta-
tion of existing machinery to the new
level of production.
The very concept of a "tariff" implies
a flow. A price list is drawn up not simply
to dispose of stocks which come casually
* Vice-president in charge of economic studies,
Electricite de France.
t "La Tarification des demandes en pointe: ap- needed to haul his weight and the wear
plication de la theorie de la vente au co-at marginal" and tear of the seat he occupies during
("Peak-Load Pricing: An Application of the Theory
of Sale at Marginal Cost").
I "La Tarification au couti marginal des de-
mandes aleatoires" ("Marginal Cost Pricing of
Stochastic Demands"), Cahiers du seminaire
d'economnetiie, Vol. I, No. 1 (1951) (Librairie de
Medicis); "Sur la gestion des monopoles publics
astreints a l'qui1ibre budgetaire" ("On the Man-
agement of Public Monopolies Required To Balance
Their Budgets"), Econometrica, XXIV (January,
1956), 22-41; "La Vente au co-at marginal" ("Sale
duction which must be used to give him
at Marginal Cost"), Revue franqaise de l'energie,
December, 1956; and "Le Tarif vert d'Electricite de
France" ("The EDF [Green] Tariff for Industrial
Consumers"), ibid., VIII (January, 1957), 1-16.
onto the market but to strike a perma-
nent balance between the flow of demand
and the flow of production. This equi-
librium will be determined according to
the flow of expenditure and receipts
which it occasions. The view held by
supporters of the marginal theory is that
rates must be fixed in such a way that
any increase in the production level (or
flow) will be exactly matched by a cor-
responding increase in the level (or
flow) of sales.
That, at least, is one conception of
marginal cost. At the other extreme is
the theory of the extra passenger. A
train is about to leave, and there is one
empty seat; a passenger arrives who is
prepared to take that seat, provided he
does not have to pay too much for it. The
cost of carrying this extra passenger is
simply the cost of a few grams of coal
his journey. Assuming that this amounts
to ten cents-and that would mean a
very long journey-our extra passenger
must, in the general interest, be accepted
on the train if he is prepared to pay at
least ten cents for his journey, since its
value to him is at least ten cents,
whereas the value of the factors of pro-
satisfaction does not exceed that amount.
The same argument is valid for all the

157

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158 THE JOURNAL OF BUSINESS

empty seats that there may be in the We shall not go into the problems
train. It is only a short step from this to raised by the random nature of demand
argue that the optimum rate, as under- butshallrefer the reader to other sources.'
stood by the marginal theory, is ten Part I of this study is devoted to the case
cents. Common sense balks at this. In of constant (and assured) demand: re-
order to make the theory "reasonable," quirements are assumed to be the same
a compromise is reached: marginal cost at any hour, day or season. Afterward,
must include the so-called partial ex- in Part II, there will be an examination
penses as opposed to overhead, which of the problems posed by periodical
will have to be covered in some other variations in demand, which are the
way. This may be done by charging the source of the problem of peak-load pric-
more wealthy customers the necessary ing.
amount by discriminatory prices (class
I. CONSTANT DEMAND
system), unless it is decided to make it a
deliberate charge on the state budget. Take a unit of time (hour, day, year,
These statements seem to be based on etc.). Let q be the quantity of a certain
a number of confusions. There may be commodity or service consumed per unit
various reasons for having surplus pro- of time; q is then a flow. If the demand is
duction capacity (empty seats, etc.). De- assumed to be steady, it follows that, for
mand may, for example, be periodic, so a given sale price, the output q is con-
that plant conceived on a scale suitable stant. It is thus the structure of demand
for peak loads will be surplus at off-peak ("needs") and not demand at a given
periods. Even at the peak, however, pro- price ("effective demand") which we
duction capacity will appear excessive; in assume to be constant over a period of
order to face variations in peak demand, time. Similarly, we assume that produc-
production capacity must provide a mar- tion possibilities are constant, though
gin of safety over and above the average, this does not prevent production itself
if a service is to be maintained under all from settling out at one or another level,
circumstances. By its very nature, this according to the price policy adopted by
margin of safety will rarely be taken up. the producer.
It would be absurd to conclude from
1. SHORT- AND LONGTERM EXPENDITURE
this that the peak rate must be calcu-
CURVES
lated as if the margin of safety was a
constant surplus of production capacity. 1.1. Plant of Flexible Capacity
Yet, "if there is an empty seat," the 1.1.1. Total expenditure curve.-In one
marginal cost does not exceed ten cents. unit of time a firm incurs a certain num-
These paradoxes are the result of hastilyber of expenses: some of these (raw ma-
applying to a complex reality the con- terials, labor) are applied directly to the
clusions of a theory which has necessari- production of the quantity q, others are
ly been simplified. expenses in connection with plant, ap-
The theory of marginal cost encoun- portioned to the unit of time.
ters no difficulty when it is applied to a The sum total of all these expenses to-
constant and assured demand; the prob-
lems appear and equipment becomes I "La Tarification au coit marginal des de-
mandes al6atoires" ("Marginal Cost Pricing of
surplus as soon as we get away from this Stochastic Demands"), Cahiers du seminaire d'econo-
overabstract situation. mttrie, Vol. I, No. 1 (1951).

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 PEAK-LOAD PRICING 159

gether constitutes the curvean expenditure

refers. Another plant of a fl
which, to simplify our language, we different normal capacity qo will have its
shall call "total expenditure," on the own maximum output qL and its own
clear understanding that this expendi- curve (D). This aspect may be empha-
ture is total insofar as it includes sized by writing the function of the total
charges relating to plant, though theseexpenditure D in the form
are allocated to the unit of time. (Break-
D= D(q, qo),
ing down overheads according to units
of time poses a number of problems where qo is a characteristic parameter of
which are outside the scope of this study
the plant in question.
and which we shall assume to have been
correctly solved.)
A plant is generally built to give a
definite output qo at normal load. Let Do
be the "total expenditure" required to
produce qo. If the output demanded (q)
is less than the normal output, expendi-
ture is reduced by the costs which may be
avoided by reducing output from qo to q.

FIG. 2.-Total expenditure curves corresponding

to plant of various capacities, showing envelope of
these curves.

1.1.2. Optimum output; optimum

plant.-For every plant capacity as
incidated by its normal output qo there
FIG. 1.-Total expenditure curve for a given
plant. is a corresponding total expenditure
curve (D). Let us imagine that plant can
If, on the other hand, an output higherbe constructed to any capacity, so that
than qo is called for, the additional ex-the parameter qo appears continuous. All
penditure required to produce the extra the curves (D) are inclosed in an enve-
quantities must be added to Do. This lope (E), which plays an essential part in
additional expenditure is partly due tolong-term pricing.
overloading the plant. It may become Let us trace on the same graph the
considerable, though in practice it ulti- expenditure curves of one plant qo and
mately became impossible to exceed a two plants of capacities q' and q"' on
certain limit qL, when the demand be- either side of the former.
comes excessive. For the plant qo, the Let qE, qfE qE be the abscissas of the
total expenditure curve (D) therefore points where the curves (D), (D'), and
assumes the form shown in Figure 1. (D") touch their envelope (E). If the
The shape and position of this curve output demanded is
obviously depend on the plant to which
q < qE

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 160 TM JOURNAL OF BUSINESS

it could be produced at a smaller total touches the envelope (E). It is natural to

expenditure by reducing the capacity qo
consider this optimum output as the
of the plant.
In particular, if q = qf, the plant best
suited to produce this output at the
lowest cost is precisely the plant q', the
curve of which (D') touches the envelope
(E) at the point whose abscissa is qE
(Fig. 2), for the point representing total
FIGS. 3 AND 4.-Curves of differential cost and
development cost deduced from short- and long-term
expenditure curves.
expenditure is then lowest on the seg-
ment of the vertical of q, which is
touched by the curves of expenditure ap- given plant of capacity qo defines a short-
propriate to the various possible sizes of term marginal cost or differential cost
plant. Similarly, if q is greater than qE
and equal to q", the plant which would
produce the output q at the lowest cost
is one which operates at a normal loading
qo'
It follows that the "optimum out-
put" of a given plant is that for which
the total expenditure curve of the plant
normal load or capacity of the plant, so
that in the future we shall designate a
plant by its optimum output qo= q=,
that is, q0 (where the index o means
"optimum").
There is an optimum output for each
plant. Conversely, there is an "optimum
plant" for any given output.
1.1.3. "Long-term" expenditure curve.
-If plant could always be perfectly
adapted to the quantity demanded, it
would be modified in step with demand,
so that it would be constantly main-
tained at the optimum capacity for that
load. The expenditure curve for each
output would then coincide with the
envelope (E).
In actual fact, plant capacity is es-
sentially static, so that constant adapta-
tion in this way would be possible only
if demand changed very slowly. The
curve (E) may therefore be called a
"long-term expenditure curve." It will
show actual (or projected) expenditure if
we are careful always to maintain plant
at the optimum capacity, keeping pace
with a slow evolution of demand.
1.1.4. Short- and long-term marginal
costs.-Marginal cost is by definition the
function dD/dq; it is equal to the slope
of the expenditure curve for a given
output q.
The slope at the abscissa point q taken
on the short-term curve (Fig. 3) of a
,y(q, qo) dD
dq
On the long-term curve (Fig. 4) a
long-term marginal cost or development
cost 5(qo) may similarly be defined
= dDo
dqO

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 PEAK-LOAD PRICING 161

If plant is completely rigid (Curve [IT);

q < qo, a< a, expenditure increases more or less in pro-
q> qoy> a, portion to output up to a limit value qL,
which cannot be exceeded.
q = qo,= y =
Curve III is seen to be the extreme
When the output demanded is greater case of a progressively less flexible curve,
than the optimum output, the differential the arms of which approach their asymp-
cost is higher than the development cost. totes (Curve II). Many industrial plants
For plant of correct capacity, the dif- are far nearer to Type III than to Type I
ferential cost and the development cost and should be treated as being of rigid
are equal: the cost per unit time of a capacity.
slight permanent overloading of the Taking Type III as an extreme case of
plant is then equal to the cost per unit Types I and II leads one to suppose that
time of adapting the plant to the new the total expenditure curve of a plant

FIG. 5.-Three types of total expenditure curve

permanent output. It seems practically

out of the question that these costs
should be equal; it is difficult to imagine,
for instance, how the marginal cost of
operating a thermal power station could
become high enough to equal the de-
velopment cost (including plant) of the
thermal energy. The paradox is due to
the fact that most industrial plants are
in reality very "rigid." FIG. 6.-Total expenditure curve for a plant of
rigid capacity.
1.2. Plant of Rigid Capacity
1.2.1. Total expenditure curve.-We of fixed capacity must be continued by
have so far assumed that plant was the vertical of qL; the optimum output qo
flexible in the sense that the load de- tends to be equal to the maximum output
manded might considerably exceed the qL.
normal output qo without coming up The total expenditure curve for a
against the technicaf impossibility im- plant of rigid capacity therefore takes the
posed by the maximum output qL (Fig. 5,form of an obtuse angle (Fig. 6) having
Curve I). In fact, the capacity of certain one vertical arm. Its apex, which is

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162 THE JOURNAL OF BUSINESS
situated on the long-term curve, shows
both the maximlum capacity and the
optimum output.
1.2.2. Marginal cost curves.-The
slope of the tangent to the curve in
Figure 6 is practically constant where
q < qo indeterminate where q = qo, and
infinite where q > qo. The same result
is obtained by considering the differential
cost curve to be the limit of a slightly
flexible expenditure curve (Fig. 7). It
FIG. 7.-Total expenditure and differential cost
curves for a plant of flexible capacity.
FIG. 8.-Total expenditure and differential cost
curves for a plant of rigid capacity.
FIG. 9.-Differential cost and development cost
curves for a plant of rigid capacity.
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will be noted that the vertical arm of the
curve (-y) corresponds on the whole to the
angle of the expenditure curve (Fig. 8),
so that the equality of y and 6 at this
point is shown by the fact that the "de-
velopment cost" curve intersects the
"differential cost" curve at a point in its
vertical arm (Fig. 9; cf. Fig. 4).
There is no longer any question of
equating the development cost to the
cost of overloading the plant, since any
such overloading is precluded by the as-
sumption of rigidity. In fact, the more
usual types of plant have some slight
flexibility in the region of their limit
capacities, and this little is shown by a
slight rounding of angle A (Fig. 9), but
in most cases the curve (-y) has already
become absolutely vertical by the time
the point M is reached. Consequently,
any "overloading" which might be con-
templated in practice would never be
sufficient to equate its cost with the de-
velopment cost; hence the paradox re-
ferred to above.
1.2.3. Partial cost.-For a plant of
rigid capacity the sloping arm of (D) is
approximately straight. Let its equation
for q < qo be D = Df + coq. This gives
D-Df AD
q q
The differential c
equal to the partial cost, which is ob-
tained by dividing the cost D - Df
(which would be saved by stopping the
plant) by the output q. If-as is always
the case-there are overheads Df, the
partial cost is necessarily lower than the
total average cost D/q. Thus, for a rigid
capacity plant working slightly under its
maximum rating, the differential cost is
approximately equal to the partial cost and
is always less than the total average cost.
These are the current ideas on the
subject; they are false in the theoretical
 PEAK-LOAD PRICING 163

general case but more or less true of
ordinary industrial plant. From the
above analysis we can add to these cur-
rent ideas a new notion which will play
an essential part in "peak-load pricing":
for an output equal to the maximum, the
these is applicable to sale at marginal
differential cost is indeterminate: it may
be equal to, less than, or greater than the
development cost.
1.2.4. Cost of plant development.-In
the formula for the "rigid" plant qo
D= Df+wq
2. PRICING FOR CONSTANT DEMAND
2.1. Short-Term Tariffs
2.1.1. Justification.-We have defined
two marginal costs, the differential cost
-y and the development cost &.2 Which of
cost?
Take a plant of capacity qo, with an
expenditure curve (D) tangential to the
long-term curve (E) at the abscissa
point qo (Fig. 10). Let q be the load de-

Df and X are a priori dependent on qo. DID* (D)

As regards overheads, */ E)

D = Df (qo)

is the function which shows the connec- Mj<

tion between the expenditure on plant
and plant capacity. The function
0 9o - N
- dDf
d qO FIG. 10.-Long-term
curves.
is the "plant development cost."
It may be taken, as a first approxima- manded. If this
tion at least, that for plant of the same the actual additional expenditure is
type, co is practically constant when qo equal to the differential dD measured at
does not vary overmuch: M on the curve (D) and not the differ-
- = Const . ential dDo measured at the point N on
the curve (E). For the plant is what it is,
With plant operating at full rating
and the additional expenditure to be
(q = qo), D becomes equal to the opti-
compared with the additional satisfac-
mum expenditure Do (see 1.2.1)tion which it procures is the supplement
Do= Df (qO) +wqo dD of actual expenditure used to increase
hence the output of existing plant by dq and not
3 Do 3 Df+ the cost dDo, which would have had to be
a qo 3 qo incurred to transform hypothetical plant
originally conceived for an output q so
where aDo/aqo is by definition the (total)
as to give a new output q + dq. The
development cost. It is therefore linked
curve (E) is a theoretical fiction: it is the
to plant development cost by the formula
expenditure curve of an undertaking
a=7r+w.
2Many others might also be defined by taking
The development cost of a into rigid produc-
consideration more or less long-term expendi-
ture curves: certain factors of production are fixed
tion is equal to the sum of the partial
and are included in plant for a unit of time equiva-
operating cost and the plant development
lent to one year but would be variable for a longer
cost. unit of time such as five years.

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164 THE JOURNAL OF BUSINESS

whose plant-by definition a fixed fac- Let us consider a plant of rigid

tor-would always be adaptable and al-
ways perfectly adapted to any fluctua-
tions of demand and therefore variable
(see 1.1.3). This fiction, introduced for
purposes of analysis, has-a priori at
least-nothing to do with pricing.
The theory of sale at marginal cost is
therefore concerned with the short-term If the point of intersection gives an out-
marginal cost or differential cost for exist-
ing plant.
2.1.2. Short-term pricing and overin-
vestment.-Marginal cost pricing is fre-
quently admitted to be an excellent sys-
FIG. 1 l.-Determination of quantities marketed
when sold at partial cost.
tem so far as the use of existing plant is
concerned, but it is alleged to lead to
overequipment. To put it in another
way, it is objected that marginal cost
contradicts itself and necessitates a
choice between the opposed require-
ments of long term and short term: "A
service ought to be supplied if it covers
its own costs." If we persist in the belief
that short-term marginal cost is neces-
sarily lower than long-term marginal
cost, the application of the principle to
an existing plant would lead to plant ex-
pansion, although the development bud-
get would not be covered by the tariff.
In other words, each service would cover
its own cost for the plant supplying it,
but the total services supplied would not
pay for plant development and thus
would not pay what it had cost as a
whole.
capacity but without joining the vertical
of qo to the total expenditure curve
and to the differential cost curve. Pric-
ing at differential cost amounts to fixing
the output of the plant at the level
where the demand curve meets the (al-
most horizontal) curve of partial cost.
put ql, which is below the maximum out-
put qo, there is surplus plant capacity
(Fig. 11). If the output at the point q2 is
equal to the maximum output qo, the
plant is said to be "saturated," and, at a
price co, any increase in the demand (q3)
would require expansion of plant. Plant
will therefore always be constructed in
such a way that demand can be satis-
fied at a price equal to the partial cost co,
and receipts will cover only operating
costs. Plant expansion is costly; it
necessitates diverting factors of produc-
tion which, if used in some other way,
would have given greater satisfaction to
consumers. If its cost is not a factor in
the prices which govern customers' de-
cisions, the plant will be expanded far
beyond what would have been justified
by a properly drawn up balance sheet of
net gain in satisfaction to the economy as
a whole.
The error which leads to systematic
overinvestment of this kind arises from
the fact that the principle of sale at
marginal cost is applicable to existing
plant but cannot alone govern investment
policy. It is investment policy which
must decide plant expansion and recon-
cile the apparently incompatible needs
of long-term and short-term demand.
2.2. Investment Policy
2.2.1.-The most economical way of
covering the output q is to adapt plant
to that output, that is, to fix the ca-
pacity of the plant at such a level that
the differential cost y and the develop-

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 PEAK-LOAD PRICING 165

ment cost a are equal (see 1.1.2). Once
plant is adapted in this way, marginal
cost pricing for that plant requires that
the price p should be equal to the differ-
ential cost 7y. It follows that for plant of tion between the two.
correct capacity
P 6.
At the optimum, the three curves of de-
mand p = p(q), differential cost y =
y(p), and development cost a = 6(q) all
intersect at the same point (Fig. 12).
When investment policy comes to be
considered, the curve -y(q) is no longer
definite, since it is relative to a specific
plant. The capacity to which the plant
should be built is therefore determined
by the equation p = 8, that is, by the
intersection of the curves of demand and
possible extension of plant. Provided
there is an optimal investment policy,
short-term pricing is also long-term pric-
ing, and there is no longer any contradic-
2.2.2. These results can be transposed
directly to the special case of plant of
rigid capacity; correct capacity is deter-
mined by the intersection of the demand
curve and the long-term curve (a), point
M (Fig. 13). For plant of this capacity
there is a corresponding differential cost
curve (7y) which takes the form of a

FIG. 13.-Determination of the optimum scale

for plant of rigid capacity.

right angle, the horizontal arm of which

is at the ordinate co and the vertical arm
at the same abscissa qo as the point M.
FIG. 12.-Determination of optimum size of
From the equation a = 7r + co (see
plant of flexible capacity.
1.2.4), together with p = y = a which
long-term marginal cost. Once this ca- characterizes the optimum, it can be de-
pacity has been decided upon, there is a duced, in particular, that
corresponding differential cost curve
P=7r+co .
'y(q) and a tariff p = sy, which, by con-
struction, is such that When plant capacity is correct, the dif-
ferential cost rates covers both running
P a.
costs (energy costs) and plant assessed
If demand, at a price p, should in- at its development cost (power costs).
crease by dq, it can only be satisfied by Assuming that the demand load is
overloading the existing plant, which constant, the power demanded is the
would cost dD = tydq. If there were time, same throughout each unit of time so
the plant might also be adapted to the that the distinction between energy
new output at a cost of dDo = 8dq.- The costs and power costs is not of major
additional satisfaction pdq is therefore importance for this purpose. It should
equal to the cost dD = ydq which is simply be noted that, for optimum
plant, differential cost pricing in no way
incurred for an increase of dq in the given
plant, or to the cost dDo = 8dq of the requires the price to be equal to partial

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166 THE JOURNAL OF BUSINESS

cost alone. In fact, plant development is contraction of investment proceeds (the

only justified when demand reaches the vertical AM moves toward the left from
point M, that is to say, when the differ- qo to qO), the rate is seen to move along
ential cost rate also pays for this develop- the curve of demand with a sharp ac-
ment. celeration when the point A reaches that
curve. All customers in the remaining por-
2.3. Long-Term Pricing tion of the demand curve who had based
Plant may be of unsuitable capacity their forecasts on an artificially low rate
for various reasons-unintentional over- will have made wrong investments. If those
equipment through erroneous forecast- investments are for a period longer than
ing, unintentional lag in equipment that of the contraction of equipment, the
through underestimating the anticipated economy will have suffered a loss which
it ought to have been spared. It follows
that when contraction of equipment
may be rapid (or, what comes to the
same thing, when a rapid expansion of
demand is expected), rates should im-
mediately be fixed at the level they will
reach after readaptation, that is, the
equivalent of the development cost 8 =
ir + cw. It will be noted that the curve (a)
is nearly horizontal, so that rates will vary
FIG. 14.-Overequipment diagram
very little as the natural expansion of de-
mand proceeds: pricing at development
expansion of demand or owing to short- cost is a stable form of pricing.
ages of materials, or deliberate over- 2.3.2. Unintentional underequipment.
equipment in anticipation of a subse- -For the same reasons, rates would im-
quent development of demand. Under mediately be fixed at the development
the marginal theory it would be neces- cost if such a solution were not impos-
sary to fix rates at the differential cost sible. In point of fact, for a rate equiva-
all the time, so that the optimum use is lent to 8 = 7r + cw, the required output
made of the plant as it stands. But the qi is greater than the maximum output
need to keep rates steady (which has qo. If the desire to keep rates steady is
nothing to do with the marginal theory) the important consideration, pricing at
makes long-term policy preferable to the development cost must be accompanied
instantaneous optimum use of invest- by compulsory (or agreed) restrictions on
ment; the underlying principle of this is consumption (Fig. 15).
to fix rates equivalent to what the differ- 2.3.3. Deliberate overequipment.-It is
ential costs would be if the plant were con- far less costly to bear the financial
stantly at correct capacity, that is, rates charges and amortizations of the surplus
equivalent to the development costs. capacity of a double-track tunnel which
2.3.1. Unintentional overequipment.- is used for single-track only in the first
In the case shown in Figure 14, although ten years than to widen a single-track
the differential cost price insures the tunnel to take a second line when double-
optimum use of existing plant, it has the track working becomes necessary in ten
fault of being very low. As the necessary years' time. In the language of econo-

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 PEAK-LOAD PRICING 167

mists, such deliberate erally leads overequipment

prices to be fixed as if the is
an "arbitrage activity" and not a "pro- plant were of optimum size (at least, for
duction activity." It has its own income: sectors in expansion).
the difference between the cost (dis-
tributed over the life of the tunnel) of II. PERIODICAL LoADs
widening the tunnel and the surplus When dealing with constant loads, we
equipment charges which burdened the found that, although it was possible for
firm's finances for ten years. So long asplant capacity to be inadvertently wrong
this difference is positive, overequipment when demand or technical conditions
is essential and its cost is recovered. It fol-varied suddenly, after a transition period
lows that from the point of view of de-it could again be correctly adapted to the
velopment cost, the only thing that new load imposed by demand or by
counts is the effective capacity of the technical possibilities. Adaptation in this
plant. That being so, the price problem
raised by deliberate overequipment does
not differ from that raised by uninten-
tional overequipment; if the anticipated
expansion of demand is not too slow, it
is advantageous to fix prices constantly
at development cost to avoid any fluctua-
tions which rates would otherwise under-
go as each new installation came into
service.3
FIG. 15.-Diagram of underequipment
2.4. Conclusions

Under the theory of selling at marginal way is impossible when demand or tech-
cost, prices must be equal to the differ- nical conditions are intermittent, if the
ential costs for existing plant. Plant is of cycle of change is shorter than the time
optimum capacity when the differential needed to readjust investments. Thermal
cost and the development cost are equal, power stations cannot be expanded in
that is to say, when differential cost pric- winter and reduced in summer; a run-of-
ing covers not only working expenses butthe-river hydroelectric plant cannot be
also plant assessed at its development constantly in keeping with the ups and
cost. Whatever the capacity of existing downs of annual water supply.
plant, the need to keep prices steady gen- A first generalization from the study
3I n the above accounts we had in mind more of constant demand loads can be made
particularly the case of expanding techniques. by replacing them by recurrent loads.
When activities are contracting, the cost of a The fluctuations may be very complex:
tunnel, for example, is not "wiped off" for a hundred
a daily cycle is superimposed on a weekly
years. Stability of rates obviously is not appropriate
for such an "ultralong" term. A middle-term curve cycle, which is itself grafted on to an
must then be taken, intermediate between the annual cycle.
curves (D) and (E) and covering only investment
the natural life of which is less than the period for Taking the particular instance of the
which it is required to stabilize rates. The marginaldemand for electricity, let us first con-
cost should be taken on this curve. sider a single period-the day. All daily
Other special cases necessitate certain precau-
tions which are outside the scope of this study load curves will therefore be identical. To
(bridges, for example). simplify matters, we will also assume

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168 THE JOURNAL OF BUSINESS

that these curves consist of two level q < q2; for these are the (daily) in-
stretches, one for the day and one for thecreases in expenditure flow resulting
night. The height at which each level from increases in the day or night load.
stands obviously depends on the day 3.1.2.-A tariff of this kind may be im-
price and night price charged, but, for a possible. To make things clearer, let us
single day (or night) price, the load de- comply with the laws of linear demand.
manded at any given moment in the day
qi= alp,+bi a,, a2<O
(or night) is the same.
with
If W1 is the power called for by day
q2-a2P2+b2 bi,b2>O.
and W2 the power called for by night, the
daily output is qi = W, X 12 hours, and For the prices [27r + co, w], t
the nightly output is q2 = W2 X 12 called for will be
hours, taking the half-day (12 hours) as
q = (27r+w)a,+b1,
our unit of time. For convenience, the
over-all expenditure of a plant will there- q2=wa2+ b2,
fore be broken down by units of time
which would be justified if q1 > q2 and,
(i.e., by 12-hour periods), and the ex-
consequently, if
penditure flow thus defined will be called
"total expenditure" D, in accordance -2ral <w (al-a2)+ b1-b2. (I)
with our usual terminology. The inter-
The outputs called for at prices [w,
val between recurrent fluctuations of de-
27r + w] would be
mand is 24 hours, so that the total ex-
penditure flow for a period of 24 hours qi = wal+ bi,
will be 2D.
q2= (27r+w)a2+b2,
3.1. Statement of the Problem which would be justified if qi < q2, and,
3.1.1.-Let us consider a plant of fixed consequently, if
capacity, having a partial operating
w (al-a2)+ bi-b2< 27ra2. (II)
cost o, a maximum capacity qo, and a
development cost for fixed charges r. If Since a, and a2 are negative, condi-
qi and q2 are the day and night demands, tions (I) and (II) cannot be fulfilled
the scale of the plant is governed by the simultaneously, and thus there will
greater of the two-normally, the day never be occasion to hesitate between
demand qi. them when they are applicable. But
Any increase in q2 (night) involves no neither will be applicable if
other expenditure than the cost of
2ra2< bi-b2+W(al-a2) <-2 ra, (III)
materials w for that output, so long as
q2 < qo. Any increase in the peak de- The conditions are therefore impos-
mand qi calls for expansion of plant. sible
The when the two demand curves are
development cost is 7r per period of 12 close together (b, --. b2, al /-' a2) or when
hours or 27r per day, in addition to the the development cost of the plant is
cost of materials co. It would therefore high. This impossibility is easily inter-
appear that the principle of sale at preted; by charging for [ql, q2] as if q,
marginal cost would require the whole were greater than q2, qi becomes less
than q2, and vice versa.
[ql, qj to be sold at the rate of [27r + w,
w] if ql > q2, and at [w, 27r + col if To express this in graphical form (Fig.

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 PEAK-LOAD PRICING 169

16), by pricing ql at 2wr + w (point M1) which they must be sold. There is
and q2 at w (point N1), q, is less than q2,nothing impossible in this.
and the solution will not hold. But pric- 3.2.2. Optimum scale.-At constant
ing q2 at 2wr and q, at 0 makes the solu-load, plant is said to be of optimum
tion still less acceptable. scale for a required output q when it is so
Thus, in certain cases, the peak is no constructed as to give this output at the
longer the highest level if it is priced as a lowest possible cost. This definition leads
peak. to the characteristic condition y=
Completely rigid capacity is an ex-
treme case, and any extreme case is a
likely source of error unless it is recog-
nized as such. In order to resolve this
paradox, we must therefore consider the
case of a plant of flexible capacity, even
though that is a purely theoretical as-
sumption.

3.2. Plant of Flexible Capacity

3.2.1. Short-term pricing.-Let (D) be

the expenditure curve of a given plant of
flexible capacity, let (E) be its long-term

FIG. 18

FIGS. 17 AND 18.-Determination of day and

FIG. 16.-Impossible case night balance positions for sale at marginal cost.

(see 1.1.2). When the load is intermittent

expenditure curve, and let qo be the
and consists of two levels qi and q2 each
optimum output of the plant (Fig. 17).
day, the optimum capacity for these out-
On the marginal cost graph the cor-
puts will similarly be defined by the
responding curves are the differential
condition that the daily expenditure
cost curve (-y) and the development cost
D(qi) + D(q2) must be as low as pos-
curve (a) (Fig. 18).
sible.
The pricing policy which insures the
It can be shown (see Appendix) that
optimum use of existing plant is differ-
the characteristic condition of optimum
ential cost pricing (see 2.1.1). If we trace
capacity takes the simple form
the day and night curves on Figure 18,
we have at the intersection with the 'Y1 + 'Y2= 2 8
curve (-y) the quantities q, and q2 to when be the development cost a is constant
marketed and the prices pi and P2 at and the expenditure curves (D) for

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170 THE JOURNAL OF BUSINESS

plants of various capacities (1) each demand

are for the period should be
congruent
and differ only in position. priced at differential cost; (2) plant
If the outputs
qi and q2 are not very should be such that the
different orarithmetical
if the
curves (D) do not alter shape greatly mean of the prices so fixed is equal to the
when the capacity of the plant is development cost; (3) if not, the plant
changed, the formula holds as a first should be modified; long-term prices
approximation. In particular, when plant must be those which would be charged if
capacity is rigid, the absence of any de- plant capacity could be constantly
formation of the curves (D) is justified if
adapted to demand.
the partial cost co is approximately the
3.3. Plant of Rigid Capacity
same for plant of different capacities.
This is the very hypothesis under which In the case of plant of rigid capacity,
the formula a = wr + w given in 1.2.4 where the partial cost is independent of
was valid. the scale of the plant, the formula
3.2.3. Long-term pricing.-Since the
7Y1+72= 28
need to have stable prices causes rates
to be calculated-subject to the reserva- is strictly applicable; and it is also true
tions already mentioned (see 2.3)-as if (see 1.2.4) that
the plant were constantly of optimum a = 7r +
capacity, prices will be worked out by
solving the system of equations formed For optimum equipment and prices
by the laws of demand, equal to marginal costs, the relation be-
tween prices and costs takes the follow-
pi = Pi (qi, ing form:
P2 = P2 (q2); P1 + P2 2 (7r + o).

conditions of sale at marginal cost, Various curves may be considered ac-

cording to the position of the demand
pi= y (qi, q0),
curves relatively to the curve ('y). As in
P2 = (q2, q0); 3.1, for the sake of simplicity, the laws of
demand are assumed to be linear.
and the condition for optimum equip-
3.3.1. First case.-Both demand
ment,
curves cut the horizontal arm of the
ac (qi,q2;qo)
q2j q) =0
=?; curve ('y). Sale at marginal cost gives
pl = P2 = w, and the condition for
that is, five equations to determine the optimum scale gives X + X = 2 (7r +
five unknowns qo, qi, q2, pi, and P2, co); hence 27r = 0, which is impossible.
among which appear the prices sought. Thus a figure of this kind can never
In cases where the simplified formula represent an optimum situation. In
'Yl + 72 = 28 applies, it may be sub- long-term pricing the peak demand always
bears a proportion, if not the whole, of the
stituted for the last condition; or, again,
power cost.
in view of the last two, it may be written
3.3.2. Second case: pricing without de-
P1+ P2= 28 . pression of peak.-Only one of the two
In this case the principles of long-termcurves cuts the vertical arm of the curve
pricing may be summed up very simply: (QY)

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 PEAK-LOAD PRICING I71

(1) Sale at differential cost. If the Allowing for the value of pi, the opti-
second demand curve cuts the horizontal mum scale is
arm X at a positive abscissa point (Fig.
qo = (27r + w) a + b,.
20)
(3) Validity of rates. For this value of
qi=qo Pi qo - bi
a, qo, one or another of the demand curves
must intersect the vertical arm of the
P2=C q2=a2w+b2.
curve ('y); hence the conditions
If the point of intersection is negative
bi-b2+ (al-a2)co<27ra2,
(Fig. 21), we shall again have or P2= (=,
but there will be no purchases at this
bl-b2+ (al-a2) C >-27ral,
price. The plant will be stopped at night.
(2) Optimum scale. Optimum scale is which are mutually exclusive. This comes
characterized by back to the conditions observed in 3.1.2,
when the pricing principles then en-
P1+P2= 2 (7r+co);
visaged did not involve an impossibility.
or, if P2 = CD, pi = 27r + co. 3.3.3. Third case: pricing with depres-
Each demand must pay for its relevant sion of peak.-Both demand curves cut
energy cost. The peak demand bears the the vertical arm of the curve ('y) (Fig.
complete plant charge 27r, as power cost. 22).

FIG. 21.-Case in which plant must be stopped

at night.

FIG. 19.-Impossible case

FIG. 22.-Case of pricing with depression of

FIG. 20.-Pricing without depression of peak peak.

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172 THE JOURNAL OF BUSINESS

(1) Sale at differential cost. We have That is the very case in which the
pricing method suggested in 3.1.2 was
qi= qo Pi q- b, impossible. We then eliminated the hy-
a,
pothesis that q, = q2, by implicitly con-
q2 = qo p =qo-P2a
b2 sidering it to be exceptional. When de-
mands are such that this condition (III)
Prices are therefore such that demand is fulfilled, efficient pricing requires that
saturates both plants. qi be equated with q2, so as to use the
(2) Optimum scale. The optimum scale maximum capacity of the plant by day
is characterized by and night. In other words, when the de-
Pl+P2= 2(7r+c). mands approximate to each other (b1
Q, or where plant is very costly (high
Both demands share the daily expendi-
value of 7r), the peak must be energeti-
ture in proportion to their "intensity"
cally depressed until the load curve is
(measured by the ordinates of M1 and
flattened. But that is not a general solu-
M2).
tion: as we have already seen (second
q q case), the load curve need not be
thoroughly flattened out when condition
(III) is not applicable, that is, when the
peak is capable of fully covering its own
inherent costs.
Where qi = q2, the method suggested
8h 20h 8h in 3.1 was in any case no solution, so
FIG. 23.-Two-level load curve that the new statement of the problem
simultaneously solves the impossible case
By hypothesis, the points M1 and M2 and the indeterminate case of the former
are situated above A; therefore, Pi and p2method and coincides with it where it al-
are not less than co: each demand at least ready offered a solution.
pays for the partial costs which it involves.
The plant charge assessed at develop- 3.4 Decomposition of the Load Curve
ment cost is distributed according to the 3.4.1. Statement of the problem .-We
formula have agreed that the daily load curve
(Pl- W) + (P2-c1) = 27r, consisted of two levels (Fig. 23); the
height of these levels obviously depended
that is, in proportion to the intensities
on the rates charged, but we admitted
AM1 and AM2 of the two demands above
that for a single day rate and a single
the horizontal co.
night rate the day and night curves were
Replacing pi and p2 by their values
horizontal. This hypothesis enables us to
given in the equations for sale at differ-
consider the over-all day (or night)
ential cost, we obtain the optimum scale
energy as an economic commodity the
_ 2 (7r +co) aja2+ alb2+ a2b, consumption of which was characterized
qO- - al,+ a2 solely by quantity and to speak of a law
of of
(3) Validity of rates. For this value daily demand linking that quantity
qo, Ml and M2 must in fact be higherwith
thanits price.
A; hence the conditions In point of fact, demand varies every
instant so that, strictly speaking, we
27ra2 < bj-b2+ (a1- a2) co <- 27ral. (III)

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 PEAK-LOAD PRICING 173

should have to consider the energy con-
sumed in each primary interval of time
dt (Fig. 24) as a particular commodity
subject to its own laws of demand.
Furthermore, the demand for energy
during the primary interval dt depends
not only on the rate p(t) charged but on
the rates for energy supplied in the
nearest primary periods. If energy is dear
at eleven o'clock and cheap at twelve
o'clock, certain consumers will transfer
part of their consumption from eleven
o'clock to twelve, though they would not
have done so if the price had been the
stant, so that the energy sent out during
Ath is characterized by its quantity qh.
A law of demand is associated with each
level h,
qh = qh (Ph) ,
relating the quantity qh consumed at a
price of ph of the commodity constituted
by "energy sent out during the time
Ath." More exactly, since the loads called
for during the various intervals At are
mutually dependent on their respective
prices, the function of demand
qh =qh (P1, P2, . . ., Pn)

will be associated with each level h.

3.4.2. Depression of load curve.-Let
us first assume that the load curve can be
broken down into, say, six levels having
independent demands

qh = qh (Ph).

The results already established can

readily be generalized. The rates to be
FIG. 24.-Infinitesimal decomposition of load
curve.
applied to the demands which make up
each level are such that the load curve
same at both times. Strictly speaking, levels out to follow a horizontal line. If,
the law of instantaneous demand for the however, for certain off-peak levels, the
period dt is a partial differential of the price needed to bring demand up to this
function p(t) of the daily rate. From the horizontal were less than the partial cost
mathematical point of view, a perfect (energy cost), the load curve would be al-
treatment of the problem would have to lowed to fall at this point instead of
be based on a double functional calcula- dropping the tariff to less than the partial
tion relating the function q(t) of the cost. Finally, the load curve after pricing
daily load and the function p(t) of the consists of a horizontal line, with "faults'
daily price. in certain places. The rate to be applied
In practice, the possibility of a tariff at these "faults" is equal to the partial
varying every instant can be ruled out. cost, which amounts to the same thing as
The best that can be done is therefore to saying that only "energy costs" are
break down the load curve into as many taken into account, to the exclusion of
adjacent levels as will adequately repre- power costs. On the horizontal parts of
sent it, though keeping the number as load curve, the cost of plant is charged to
low as possible. Let Ath be the interval ofthe various levels of demand in such a
time corresponding to the level h(h = 1, way as to (1) bring them back to the
2, .. . , n for n levels). It is agreed that level of the horizontal under the pressure
the time Ath the power called for is con- of the prices resulting from the distribu-

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174 THE JOURNAL OF BUSINESS

tion of costs and (2) recover isolated group the over-all

of stations of the same
cost of plant at development cost, this type. The interconnection of power sta-
second condition determining the precise tions using different means of generating
level of the horizontal to be produced by current will make it much easier to iron
the intensity of demand at each level. out the demand curve in the manner
The dotted line in Figure 25 shows the recommended. It was also agreed that it
load curve obtained for a rate that is uni- is possible to differentiate rates during
form in time, and the continuous line the day into as many rates as there are
levels needed to represent the load curve
accurately. Anyone can see that this is
practically impossible for domestic sub-
scribers, for instance, and that an ap-
proximation is necessary. We must also
be sure exactly what ideal we are seek-
ing; that is the purpose of this study.
3.4.3. Spreading the load curve.-A
load curve consists of adjacent demands
FIG. 25.-Load curve before and after peak-load which, as already stated, are either per-
pricing; breakdown into six levels. fect substitutes (a water heater can be
used at some other time of day without
any great inconvenience) or are strongly
complementary (an electrified factory
needs power for a specified period or not
at all).
The new generalization does not af-
fect the preceding results but only the
machinery for restoring the balance.
Apart from direct pressure of the price
ph (h = 1, 2,.. ., 6) on the energy qh
consumed in a period of time h, the ef-
FIG. 26.-Load curve before and after peak-load
pricing.
fects of interchangeability will drive part
of the consumption from this period on to
shows the curve obtained after "peak- cheaper ones, so that the load curve will
load pricing." Demands 1, 3,4, and 5 are be leveled out partly by depression and
depressed to the level of the horizontal qopartly by stretching.
by an appropriate charge for each of 3.4.4. "Investment responsibility" (see
these demands to cover the cost of plantFig. 26) .-Let us take the load curve for
constructed to carry the load qo. De- a uniform tariff (continuous line). The
mands 2 and 6 bear only the energy costs.peak hour H is solely responsible for the
It is presumably unnecessary to draw volume of plant capacity. But if the full
the reader's attention to the theoretical daily power costs were therefore charged
nature of these results. to this load and the energy consumed at
It must first be remembered that all other times of the day bore only the
the customers who make up each succes- energy costs, the peak would move
sive level of demand were assumed to be along to H-1 or H+ 1 and could
connected to the terminals of a single, never be taken into consideration for
independent generating station or an price-fixing.

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 PEAK-LOAD PRICING 175

This phenomenon has attracted the 3.4.5. Multiple cycle.-Owing to the

attention of electricity distributors for alternation
a of the seasons, the demand
long time and has led them to abandon for electricity has a recurrent annual pat-
marginal pricing-which in any case was tern which is grafted on to the daily cycle
wrongly interpreted-in favor of spread- (omitting the weekly cycle, for the sake
ing power costs according to a number ofof simplicity). The annual load curve, for
coefficients representing a certain "peak example, may be divided into four
responsibility" which is defined in ad- adjacent sections. For each section
vance. s(s = 1, 2, 3, 4) there will be a charge r,
In reality, the marginal theory makes per cent of the annual power charges
it necessary to depress the load curve needed to level out the sections. The
(broken line) whenever this can be done daily proportion of the development
without bringing the hourly rate below cost ir will be replaced in the calculation
energy costs; over the entire horizontal of rates for any day in the season s by the
portion of the resulting load curve thereseasonal rate r8ir, so that the total in-
is therefore "responsibility" because vestment responsibility for hour h
power charges (and not energy charges) throughout season s will be
are shared, and the investment responsibil- rh r8 .
ity of an hourly demand qh will be exactly
defined by the proportion of the power costsIn a multiple cycle, investment responsi-
which must be charged to that demand inbility is the product of the separate invest
order to bring it down to the optimum hori- ment responsibilities of each component
zontal level, that is, rh per cent. period.4
The non-horizontal portion of this
III. CONCLUSIONS
curve defines the periods which bear no
investment responsibility (rh = 0). All The proposals resulting from this
the previous cases have referred to the study may be summed up very simply:
collective demand at the terminals of the the aim of pricing is to make the collec-
power station under consideration. tive ioad curve take the form of the
Let i = 1, 2, . .. , nh be the customers optimum diagram of producible energy,
whose individual demands add up to the provided that this price shall in no case
collective hourly demand qh: fall below the partial cost (energy cost).
For daily peak-load pricing in the case
qh qh of a thermal power station, for example,
it will be necessary:
The customer i will 1. pay for
To fix rates his
according to the consump-
hour or hours of
tion qh: (1) wql forconsumption.
energy costs and
2. To charge high rates at times when consump-
(2) (r, . ir)q' for power costs (where ir is
tion would tend to rise above the level of
the development cost of the plant, capacity, so as to bring the corresponding
broken down by daily periods). portion of the load curve down to the hori-
It will be noted that all customers whozontal.
take current at the hour h will have the same
4 The same principle of analysis would apply to
investment responsibility irrespective seasonal
o] variations in the production of a run-of-the-
their consumption. On the other hand, theriver hydroelectric power station subject to seasonal
variations of hydro conditions (see "La Tarification
power costs chargeable to hour h(rh -r -qh)
des demandes en pointe: application de la theorie de
are distributed among subscribers in pro-
la vente au coi6t marginal," Revue gdndrale de l'dlectri-
portion to the power called for qh. cite, LVIII [August, 1949], 321-40, par. 4).

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 176 THE JOURNAL OF BUSINESS

3. To fill in any dips by charging low rates. cisions according to what it would cost to
All times at which consumption at the price supply energy if plant were constantly
fixed cannot attain the level of capacity,
maintained at optimum capacity and
will be charged at partial cost; at times when
consumption at such low rates would rise not according to momentary conditions
above this level, enough higher rates will be of overequipment or underequipment.
charged in order to peg them there. It is often a long way from theory to
4. After efficient pricing, the load curve be- practice. Is it possible or desirable to
comes horizontal, with "hollows." During
charge rates which vary according to the
the off-level hours, the rate charged will
cover energy costs only. The level hours bear time of day or the season of the year?
rates which will also cover daily power Electricite de France has just made
charges assessed at development cost when the experiment by introducing a new
the level is adjusted to demand. tariff, known as the "green tariff,"5 which
Insofar as these proposals are intended is based on marginalist principles. Two-
only to "spread out the peaks" and "fill thirds of the electrical energy supplied at
in the hollows," they may seem simple high tension has been brought gradually
enough to provoke doubts as to the need under the new formula since its introduc-
for expressing the problem in the form tion two years ago. An appreciable de-
of equations, when traditional common pression of the peak (estimated at
sense solved it without effort. 400,000 kw.) has already been estab-
But common sense is purely tradi- lished. The corresponding saving in the
tional. Once the conditions of the prob- investment program6 amounts to some
lems it claims to solve are changed, 100 million dollars, and it is estimated
tradition is superseded by a purely that it will reach 200 million dollars when
logical study of the new facts. Even ifthe thetariff is fully applied.
study proves the complete validity of Of course, not all of this will represent
traditional methods, it is no less essen- a net saving to the nation, for sub-
tial just because it is a proof. scribers who have changed their load
On the other hand, common sense curve in order to obtain the benefit of
may be the expression of a long-standing lower prices have experienced some in-
error and must prove the arguments it convenience which must be set against
puts forward when, as with marginal the saving made. It is nevertheless true
costs, it comes up against theories as that the very fact of making peak con-
paradoxical as: "prices should be equal sumers pay what their consumption
to partial costs and all fixed charges actually costs has led subscribers to re-
should be borne by the state." vise their behavior in a way that can
A theoretical explanation was not un- only be beneficial. This open incentive to
called for. The one we have proposed help to improve the productivity of the
rests on a few simple principles: electrical
nation as a whole is not one of the least
energy sold in a given place at a given merits of price mechanisms; it would be
time is a definite economic commodity, wrong to fail to use its possibilities to the
whereas electrical energy as such or full.
energy supplied to, say, the textile in-
dustry is not; so-called rigid plant, the
r"Le Tarif vert d'Electricite de France" ("The
EDF Green Tariff"), Revue franqaise de l'gnergie,
capacity of which is rigidly determined,
VIII (January, 1957), 1-16.
must be considered as an extreme case
6 P. Masse, "Quelques incidences economiques du
of "flexible capacity" plant; long-term tarif vert" ("Some Economic Effects of the Green
pricing must guide the customer's de- Tariff"), Revue franqaise de l'energie, May, 1958.

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 PEAK-LOAD PRICING 177
APPENDIX
CALCULATION OF OPTIMUM CAPACITY FOR INTERMITTENT LOADS
First let us revert to the algebraic
formulation of the problem in the case of a
-constant load.
CONSTANT LOAD
1. The expenditure per unit time needed
to produce an output q with a plant of
"size" qo is expressed as
D= D(q, q0).
The differential cost for the plant qo, in
terms of q, is
y (q, qo) aD (q, q0)
2. The value of qo which represents the
optimum plant required to produce an out-
put q is obtained by reducing D to a mini-
mum,
a D (q, qo) = 0, (1)
a qo
which defines qo as a function of q.
It has already been agreed to define the
"size" or capacity of a plant by its optimum
output so that, by definition of qo, equation
(1) is equivalent to
qo= q.
When plant capacity is kept constantly
on the right scale to produce the quantity
called for qo, expenditure is shown by the
equation
Do= D(qo, qo)
which defines the curve (E) on the diagram
(qo, Do).
The development cost a on the abscissa
qo is then
=dDo OD q)
qo) qo+-(qo, o)
,a qD
3. The differential of the function of ex-
penditure D(q, qo) is written
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dD=-_D_q,_ q q+aD(q, qo) d qo
cl (q, qo)dq (3)
=7dq+ -D dqo.
0qo
In order that condition (1) be satisfied, it is
necessary and sufficient that
d D= yd q (4)
for all values of dqo. When the plant is cor-
rectly scaled to demand, the variation in total
expenditure is the same whatever readjustment
of capacity is made to face an increase in
demand.
4. For instance, the capacity of the plant
can be increased in such a way that dqo =
dq. The above differential relationship can
then be written
dD
dqO '
Now at the optimum, q = qo so that,
where dq = dqo, the change in expenditure
dD can be written (see eq. [3])
d D D (qoqo) dqo + 0 D (qoqo) dqo,
a3q a3qo
which is equal to a(qo) (se
5. Thus optirnum conditions can equally
well be expressed as
a D (q, qo) = 0, (a)
d D= yd q for all values of d qo, (b)
or
a= 6. (c)
PERIODIC LOAD
When demand is intermittent, the first
two forms of the optimum condition can
readily be reproduced, though the third,
which owed its simplicity to the fact that, at
the optimum, the "size" qo of the plant was
equal to the demand q, no longer finds a
homologue except in special cases (a size qo
 178 THE JOURNAL OF BUSINESS

c-annot be simultaneously equal to the two

loads ql and q2).
dC =[dD (q1, qo) +cD(ql, qo)]
d qo O9q a o()
6. The expenditure which must be kept
to a minimum is that of the period under
consideration (24 hours),

D(ql, qo) + D(q2, qo), a complex result strongly contrasting with

that obtained in the case of constant de-
which, for the sake of simplicity, we shall mand, where the development cost a was
express as C (ql, q2; qd). immediately evident.
The opt'imum size of a plant which has to 9. If, however, it were possible to replace
produce qi and q2 is determined by the qi and q2 by qo in the right-hand side of the
equation equation, this would be equal to twice the
dC development cost (see eq. [21), and the
- (qi, q2; qo) -0, optimum would then be given by the simple
Ol qo
relationship
which defines qo as a function of q, and q2. 2 6 =71 +72 . (6)
7. Since the differential of C is
For such substitution o
dC= 9 D (ql, qo) d aD (q2) qo) d q2 in the right-hand side of equation (5) to be
permissible, it must have no effect, and,
hence, the expression
+-ac(ql, q2; qo)dqo
09 qo
al D ( q' qo) + a D ( q' qo)X
=-idqi+72d q2+ + C dq0,
in which q= q or q = q2 are replaced by qo
must be independent of q. This means that
the condition which must be fulfilled to make
the function D(q, qo) must satisfy the
aC/aqo equal to zero is that the variation in
identity
expenditure should satisfy the equation

d D=-ld qi +72d q2 aq2 ( q ?qo) + (q,qo

for any adjustment of size (made once and The
all) to meet the two increases dq1 and dq2
equation
and night loads, respectively).
8. Let us consider the particular case of
an equal increase in the day and night loads
in which f(x) and F(x) are arbitrary func-
dql = dq2
and of an adjustment of the size dqo equal
to that common value. If the plant is of
optimum capacity, we should have
dC
o q- 7 = +72
Where dq1 = dq2 = dqo and bearing in
mind that, by definition, C(q1, q2; qo) is
equal to D(q,, qo) + D(q2, qo), the differen-
tial dC may be written, after dividing by
dqo,
for general solution of this differential
(day is
D(q, qo) _ f (q- qo) +F(qo) , (7)
tions.
10. Without departing from generalities,
let us agree to bring the constant f(O) into
the function F(x) in such a way that f(O)
shall now be zero.
Under these conditions, the function of
long-term expenditure is
Do = D (qo, qo)=_F (qo) .
But, as we have not already done so, we
must state at this point that the parameter
qo, which characterises optimuam capacity, is
equal to optimum output.

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 PEAK-LOAD PRICING 179

From the result obtained b) The translation

in isparagraph
made parallel to the 4,
the optimum scale is straight line
shown in particular by
the equality, at the point qo on the abscissa,
Do= 8qo+k,
of short-term and long-term marginal costs:
which is tangential to the expenditure
a D (qo, qo) d D (qo, qo)
curves at the point qo on the abscissa.
a q = dqo It follows that the curves y(q) may be ob-
tained from one another by horizontal transla-
When the function D(q, qo) takes the
tion when qo varies. (It can also be proved
special form of equation (7), it follows (the
primes indicating derivatives) that
directly that, if the function D[q, qo] takes
the form of equation [7], and if F[qo] is a
f ' (?)-=_F' (qfo) . straight line, there is an identity

F'(qo) is therefore a constant, the develop- OD[q, qo] _D[q+x, qo+x]

ment cost a is independent of qo, and the
Oq cq
long-term expenditure curve F(qo) is a
straight line: for all values of x.)
12. It can be shown, generally speaking,
F(qo) =Oqo+ k
that the optimum capacity of a plant under
11. Finally, the expenditure equation as- intermittent load with n steps ql, q2, ...
sumes the form qn, is represented by the simple condition

D=f (q-qo) + (qo+ k). 7'1 + 72 + + 7Yn

This special form of the expenditure func-
tion is readily understood:
a) The short-term expenditure curves
D(q) may be of any shape but can be de-
duced from one. another by simple transla-is constant.
tion when qo varies. (It is sufficient to set
q *--= o
D*=D- [ qo+k],
in order to confirm that, relative
coordinate axes, the equation of the ex-
penditure curve simply becomes
D*e = f [q*]
which is independent of qo.)
n
provided that (1) the shape of the expendi-
ture curve is independent of the capacity of
the plant and that (2) the development cost
It will be noted that such restrictive con-
ditions are necessary only locally; the curve
(E) should behave like a straight line
around the optimum value qo, and the
differential costs should depend only on the
to the
difference q -newqo in the neighborhood of the
values qi and q2 of the outputs on the ex-
penditure curve for the optimum plant.
In most cases, the formula suggested is
therefore largely valid as a first approxima-
tion.

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