Optimal pricing and capacity choice for a public s

Authors: Fred Schroyen Adekola Oyenuga

Publish Date: 2011/03/22

Volume: 39, Issue: 3, Pages: 252-

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Abstract

We develop rules for pricing and capacity choice for an interruptible service that recognize the interdependence between consumers’ perceptions of system reliability and their market behavior 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

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