Peak Pricing, Congestion, and Fairness

The classical peak-load pricing model is extended here in two ways: first, we incorporate a crucial attribute of most peak—off-peak issues in reality—the fact that the associated congestion causes disutility, through delays, crowding, etc. Second, we investigate formally the equity of the peak-pricing solution,1 comparing it with uniformity of pricing in all periods — an issue that has disturbed observers outside our profession, but that economists have often ignored. We offer a number of surprising conclusions: 1 There are several cases, at least one of them apparently common and significant, where, paradoxically, the optimal price in the more congested of two periods is lower than that in the less congested period. 2 Even in the classical model, where required expansion of capacity is the only social cost of high-pcak demand, the optimal-peak price may be lower than the uniform price that just permits total cost to be covered. This will be true when there are sufficient diseconomies of scale in capacity construction, or when the required capacity is so expensive relative to the maximum amount peak users are willing to pay that its cost cannot be covered without a contribution by off-peak users, or where the Ramsey adjustment in prices required by the absence of constant returns is sufficiently favourable to peak users. 3 Where conclusion 2 holds, adoption of peak-off-peak prices may be a Pareto improvement over uniform pricing, but it need not be so since the price to off-peak users may actually be raised in the process. 4 In the model with disutility of congestion there seems to be a wider range of cases where the adoption of optimal-peak prices is a Pareto improvement. Nevertheless, this is by no means a foregone conclusion.