Optimal pricing and capacity choice for a public service under risk of interruption

We develop rules for pricing and capacity choice for an interruptible service that recognise the interdependence between consumers' perceptions of system reliability and their market behaviour. Consumers post ex ante demands, based on their expectations on aggregate demand. Posted demands are met if ex post supply capacity is sufficient. However, if supply is inadequate all ex ante demands are proportionally interrupted. Consumers' expectations of aggregate demand are assumed to be rational. Under reasonable values for the consumer's degrees of relative risk aversion and prudence, demand is decreasing in supply reliability. We derive operational expressions for the optimal pricing rule and the capacity expansion rule. We show that the optimal price under uncertainty consists of the optimal price under certainty plus a markup that positively depends on the degrees of relative risk aversion, relative prudence and system reliability. We also show that any reliability enhancing investment - though lowering the operating surplus of the public utility - is socially desirable as long as it covers the cost of investment.D11, D24, D45, H42, Q25

Pricing of an interruptible service with financial compensation and rational expectations

This paper proposes a pricing framework that combines the occurrence of supply interruptions with financial compensations. Consumers post ex ante demands for a designated period. These demands are met if ex post supply capacity is sufficient. However, when supply is inadequate, all ex ante demands will be equi-proportionally rationed with compensation being paid for any unserved demand. Consumers posts their demands based on their expectations on the reliability of the supply system. The model is closed by imposing rational expectations. We identify that while a consumer's ex ante power demand will be decreasing in the power price and increasing in the compensation rate, it will be increasing when there is a mean-preserving spread in the riskiness of future supplies, provided the consumer is sufficiently prudent, i.e., when his coefficient of relative prudence exceeds two, and his coefficient of interruption aversion exceeds one. We also derive the welfare maximising price and show that when consumers are sufficiently prudent, pessimistic (equilibrium) expectations on the supply reliability warrant a higher price compared with a situation of supply adequacy

Optimal pricing and capacity choice for a public service under risk of interruption

Service interruption, Rationing, System reliability, Second-best pricing, Capacity choice, Prudence, D11, D24, D45, H42, Q25,