An Alternative Model of Interruptible Service Pricing and Rationing

Abstract

The theory of interruptible service pricing concerns the choice of monopolistic pricing and rationing for a firm usually a public utility with fixed capacity. The analysis is an offshoot of the more familiar peak load pricing model. The latter as formalized by Steiner [10] and Williamson [14] is characterized by nonstochasticity, sequential peak and off-peak periods and as described by Takayama [12, 2] the assumption that the peak period demand should always be satisfied. The introduction of stochastic demand by Brown and Johnson [2] shifted attention from pricing and capacity selection alone to include that of rationing. Since peak period can occur at any time with the stochastic demand and to any probable extent some form of rationing is necessary. Brown and Johnson assumed an unspecified costless rationing system based on willingness to pay. Meyer [7] introduced an exogenously determined constraint on reliability in satisfying randomly shifting demands for a public utility service. Crew and Kleindorfer [3] examined the problems associated with seeking the optimal level of reliability when rationing costs are an increasing function of excess demand. In a very general framework Sherman and Visscher [9] examined the problems of second best pricing for both expected profit and expected welfare maximizing monopolists when nonprice rationing methods are used. Additional contributions to the interruptible service pricing literature include those by Marchand [6], Panzar and Sibley [8], Tschirhart and Jen [13], and Dansby [4]. Marchand was the first to point out an essential reality of the interruptible service pricing problem. Rationing based on continuously varying prices is usually infeasible due to the excessive information costs to consumers. On the other hand, differential prices can be issued to different consumers or consumer groups based on their respective treatment during rationing situations. From a political perspective, it is preferable that consumers receiving better service during rationing periods also pay higher rates. However, the rates, once established, would remain constant over all periods. Marchand examined a two-part system of electricity prices based on mean and maximum consumption. Since the