A Framework of Peak Load Pricing with Strategic Firms

We analyze firms' investment incentives in markets where demand at spot markets is fluctuating and storability of the output is limited. Firms will then find it optimal to invest in a differentiated portfolio of technologies in order to serve fluctuating demand. For optimal behavior of firms, this has been analyzed in the so-called peak load pricing literature—cf. Crew and Kleindorfer [Crew, M., P. Kleindorfer. 1986. The Economics of Public Utility Regulation. MIT Press, Cambridge, MA]. We analyze the case of strategically behaved firms. We derive the equilibrium of the investment game and compare it to the benchmark case of optimal investment. We find that strategic firms have an incentive to overinvest in base load technologies but choose total capacities, which are too low from a welfare point of view.