Price
I t Unit
I
I I -I +
0 Qo 5 5 kwh
Fig. 2. The effect of capital indivisibilities on price.
supply may be increased to an intermediate level Q’, at the
price p’. Observation of the excess demand MN indicates that
both the supply and the marginal cost price should be further
increased. Conversely, if we overshoot L and end up in a situation
of excess supply, then it may be necessary to wait until
the growth of demand catches up with the over capacity. In
this iterative manner, it is possible to move along the marginal
cost curve towards the optimal market clearing point. Note
that, as we approach the optimum, it is also shifting with demand
growth, and therefore we may never hit this moving
target. However, the basic rule of setting price equal to the
marginal cost and expanding supply until the market clears, is
still valid.
B. Capital Indivisibilities and Peak Load Pricing
Owing to economies of scale, capacity additions to power
systems (especially generation) tend to be large and long-lived,
resulting in lumpy investments. Suppose that in year 0, the
maximum supply capacity is Q, as shown in Fig. 2, while the
optimal price and output combination (PO, Qo) prevails, corresponding
to the demand curve DO and the short-run marginal
cost (SRMC) curve (e.g., fuel, operating, and maintenance
costs). As demand grows from DO to D1 over time, with capacity
fixed, the price must be increased to p1 to clear the
MUNASINGHE: MODERN ELECTRICITY PRICING 335
0 h av. kwh pr hour
Fig. 3. Basic peak load pricing model.
Fixed Targer
Reilabillry
Lerei. R
Econornjc
EffKlanCy
Obpctir Fairnm. and
F8nincm Viabiiiry,
Sccial-Subsidy,
Other Objectives
Fig. 4. The use of price feedback in estimating LRMC based tariffs.
market. When the demand curve has shifted to D2 and the
price is pz , new plant is added on. Once the capacity increases