Subsidy free pricing of interruptible service contracts

Abstract

This article analyzes the issue of cross-subsidy in the pricing structure of a utility offering interruptible service contracts. Utilizing a simple theoretical model in which available capacity is subject to random shocks, we derive a set of sufficient conditions for the presence of subsidies in the pricing of priority service. We find that low priority customers receive no subsidies whenever they pay prices in excess of variable costs. A test for subsidies to high priority customers is derived that can be implemented utilizing available information. Extensions of the analysis are discussed.