The Response of Large Firms to Different Schemes of Time-of’Use Pricing When the Production Function is Quadratic

Abstract

This paper constructs a model of firms’ behavior before and after the introduction of time-of-use (TOU) pricing of electricity, encompassing optimal behavior under both flat-rate and time-of-use pricing. The model aims to be consistent, constraining those parameters not affected by time-of-use pricing so that they are the same under both price schemes. However, it also accounts for the new conditions (structure) under which the firm must operate once time-of-use pricing is adopted. The results show that the optimal capital under the flat rale is identical to that under revenue-neutral TOU. Almost all the firm’s adjustments take place at the time that the time-of-use pricing is introduced, and only very few additional adjustments take place in the long run. These results contradict the widely-held belief that the firm cannot redistribute its electricity use over the day very quickly but can do so in the long run, once the capital input has adjusted to the new conditions.