SERVICE-RELIABILITY DIFFERENTIATED PRICING WITH SPECIAL REFERENCE TO ELECTRIC UTILITIES (PRIORITY PRICING, CONGESTED SYSTEMS, PRODUCT DIFFERENTIATION)

Owing to the uncertainty in supply availability and demand, there is always a certain amount of "unreliability" in the service provided by a public utility such as an electric utility. Consumers have a willingness to pay for the service when it is offered at perfect reliability. They also incur a shortage cost as a result of the unreliability in the service. There is heterogeneity among the consumers along both these dimensions, viz. the willingness to pay for perfect reliability and the shortage cost due to the unreliability in the service. Based on a knowledge of the distribution of these parameters, the utility can offer a range of reliabilities or priorities of service and price them accordingly, so that consumers can choose from a menu of alternatives.;It is shown that with the provision of multiple priorities, the quantity supplied for any given capacity is increased, thereby increasing the capacity utilization. In general, the reserve capacity requirement will be lowered with reliability differentiation, making the consumers as well as the utility better off at the same time. This is especially relevant when the supply capacity is scarce or when the costs of capacity expansion are high. Reliability-differentiation is especially beneficial during the peak periods, when the demand is more likely to exceed the capacity. The results of this research have relevance in the broader context of efficient allocation of services under congestion externality.;There results a positive net benefit from service-reliability differentiation or interruptible supply pricing, as it is otherwise called. This net benefit can be shared by the consumers and the public utility. On the one hand, the public utility can make sure of a minimum revenue to cover its costs and price the service in such a way that the consumers get all the additional benefit. On the other hand, if it is an investor-owned utility, it can extract a higher surplus subject to any rate of return constraint posed by the regulator. The hypothetical case of a pure monopolist is also considered. Conditions on the consumer demand distribution and those on the supply characteristic of the monopolist, under which there will be guaranteed positive net benefit to consumers and/or utility, are derived.