Optimal Pricing and Capacity Under Well-Defined and Well-Known Deterministic Demand Fluctuations

Fluctuations in demand require diverse considerations with respect to planned capacity. At peak periods, decreased capacity may result in supply shortages and thus in lower revenues and unachievable profits. In contrast, smaller capacity at off-peak periods reduces the substantial costs of large and unutilized capacity. The questions to be addressed ask (i) what the optimal pricing policies are at peak and off-peak periods; (ii) what the optimal capacity is for profit maximization of the supplier; and furthermore (iii) how the shifting of demands from peak to off-peak periods may reduce fluctuation and impact profits. The present paper develops a model that compares two cases. In Case 1 it is not possible to transfer partial demand from a peak period to an off-peak period, while in Case 2 it is possible to do so. The comparison between the cases illustrates various results, some of which are less intuitive than others. For instance, a larger gap between the peak and off-peak periods leads to a larger optimal capacity in Case 1 than in Case 2. However, a smaller gap presents a different picture. When there is less willingness to switch demand between the periods, the capacity of Case 2 is larger than that of Case 1.