According to Lee (2010), peak pricing is “a pricing strategy that implies price will be set at the highest level during times when demand is at a peak” (Lee 34). This pricing strategy is often applied especially by the governments to try to alter the demand and consumption of some services or goods in order to contain the supply function. The reasoning under peak pricing is that charging higher prices for commodities in the market when the demand is very high is a prerequisite for balancing the supply side and the demand side to avoid the occurrence of any major shortages on either side of the demand and supply spectrum. For instance, if a commodity’s price is set at a high cost and there is a consistent demand for it, there is a high possibility of balancing the capacity to supply the commodity in the market (Hamilton 367).
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Basically, peak pricing is used as a pricing discrimination strategy to ensure that there is a balance in consumption of a commodity between high consumption period and low consumption period with minimal interference with the supply side of the market. Therefore, any consumer who wishes to purchase such a product in high season will have to pay more than a consumer who wishes to purchase the same product during the low season.
In a graphical presentation, the function of Marginal Cost (MC) is always constant up to the point where the quantity of commodity products reaches a maximum in a firm. At this point, the MC line is vertical. Therefore, “since firms optimize profits when MC=MR, shifts in MR and MC effect the price. As demand shifts outward, Marginal Revenue increases. As a result, the point where MR=MC increases and higher prices result” (Lee 38). This is illustrated in the graph below.
The real example of the application of peak pricing occurred in the US in 1970 when the government had to increase gas prices due to very high levels of consumption as the culture of muscle cars dominated the US road. The demand for gas was on the rise as more Americans were able to afford the high engine capacity cars. In response to the high unsustainable demand for gas, the government decided to raise the price of oil per gallon to arrest the high levels of demand (Blanchard 24).
This action resulted in reduced demand for gas due to the high price tag per gallon. Again, from the year 2013, the US government decided to lower the price of gas per gallon to respond to the low season demand as a result of dampened global oil prices as a result of increased production of alternative energy sources. As a result, the demand for gas has increased in the US due to the action of the government to reduce the price per gallon.
From this example, the intention of the government of the US was to attempt to “balance supply in demand by encouraging consumers to purchase at lower prices and still provides consumers willing to pay the increased price the gas” (Hamilton 369) during low and high seasons, respectively.
The use of this pricing discrimination tool enabled the US government to supply enough gas to customers who could afford to pay for the high prices during high peak, thus satisfying the market demand and vice versa. The peak pricing strategy was an instrumental tool applied by the US government to avoid gas shortages during the 1970s when the demand was very high against limited supply.
Blanchard, James. “The Macroeconomic Effects of Oil Shocks: Why are the 2000s so Different from the 1970s?” NBER Working Paper 13368, 14. 5(2011): 23-32. Print.
Hamilton, John. “What is an Oil Shock?” Journal of Econometrics, 113.12 (2008): 363-398. Print.
Lee, Friedman. The Microeconomics of Public Policy Analysis, New York, NY: Princeton University Press, 2010. Print.