We end the book with analysis of a problem that has a long and important tradition in the theory of public policy. This topic is particularly appropriate for discussion here because it draws on and illustrates many tools of analysis developed earlier. In particular, the ”peak-load” problem involves an important element of user nonrivalry, is inherently intertemporal in nature, incorporates several different levels of decentralization, and requires the use of surplus measures in a fairly sophisticated way.

We discuss a version of the peak-load problem having the following specific features. Some type of public service is produced using capital (referred to as capacity) and variable inputs. We will think of both capacity and services as one dimensional, although this is done for simplicity rather than because of any inherent difficulties in the generalization. Construction of capacity involves economies of scale. We implicitly assume that these are important enough so that efficient construction sizes are likely to affect the demand price for services; consequently, we will need some measures of surplus to evaluate welfare changes. Examples of projects that fit this mold reasonably well include bridges, highways, and power projects. Despite the fact that uncertainty about future demand is undeniably an important feature of such projects, we will not deal with it here.

Several features of this description should be familiar from earlier chapters. For example, capacity plays the role of common property discussed in Chapter 5, and the presence of an increasing returns element fits the framework of the Ramsey pricing model in Chapter 8.