Question

Pls explain, “(why) the producer should be charging a peak-period fee” if necessary pls create an example and also plot the graphıics

Answer 1

o Peak period pricing also known as Peak Load pricing is a mechanism where in the producer charges a higher price for goods in the peak period as compared to the prices charged in the non-peak periods. Such kind of pricing mechanism is generally used for goods which can’t be stored such as Air-fares, electricity, telecommunication, entertainment shows, etc.

o In peak periods, the marginal cost is very high as the capacity to produce the good is limited. Here more variable inputs are required, because of which the prices are set to the highest level with an aim to shift the demand so as to create a balance between the demand and supply of the respective good. This is required to regulate the demand so that it does not go beyond the manageable level of what can be exactly supplied.

o For example, during extreme summer seasons the tourists prefer to travel more to hill station in order to enjoy the cold weather. During such periods the air fares to hill-stations are much higher as compared to the fares in the off season (winter season).

o Another example can be the demand for electricity during summers, which is much higher during the day time as most of the offices and educational institutions are operational during the day time. However, its demand is much less during the nights. So the electricity board /firm would charge a higher price for the units consumed during day time as compared to the night.

o Refer to the below figure which shows the demand and pricing strategy for electricity during 2 periods in summer time :

Day: Peak Period; Night : Non – Peak Period

The X – Axis shows the Quantity and Y-axis shows the prices.

D1: Demand Curve in the Peak Period

D2: Demand Curve in the Non-Peak / Off Season period

MR1: Marginal Revenue curve in Peak season

MR2: Marginal Revenue Curve in Non-Peak / Off Season period

P1: Peak Period Price P2: Non Peak Perod Price

Q1 : Peak Period Quantity P2: Non-Peak Period Quantity

MC: Upward Sloping Marginal Cost Curve: Given the installed capacity, an increase in production leads to an increased marginal cost. MC is given by change in the total cost when one more unit of output is produced. In the short run, increase in production means more uses of variable inputs. This makes MC curve upward sloping as there is diminishing returns to such variable inputs.

Under peak price setting situation, the firm behaves like a typical monopolist. Setting prices equal to the Marginal cost is not sustainable, because here firms would not earn any profits on the capacity and thus would lose business. So the optimal situation is to set a price higher than the marginal cos. Thus, Equilibrium is given by the following condition:

1. Marginal Revenue = Marginal Cost

2. Marginal Cost Curve intersects the MR curve from below

Thus the prices charged during the peak period is P1 and the prices charged during the non-peak period is P2, such that P1>P2. The qunatity demanded is less during the non-peak period (Q2<Q1). Thus we can say that a peak period fee helps in balancing the capacity usage of goods. It reduces the growth of the peak load thereby decreasing the need of capacity expansion in the long run.