18.02.2009 – Pricing of an Interruptible Service with Financial Compensation and Rational Expectations

18 février 2009

18 février 2009Lille

Fred Schroyen
– Norwegian School of Business and Economics (NHH Bergen)

Date and place
18/02/2009 at 14:00
IÉSEG School of Management – 7 rue Solférino – 59000 LILLE
Lecture Room: E21 (second floor)

IÉSEG Seminar
jointly with LEM UMR8179

Co-Author(s) of the underlying paper with Adekola Oyenuga

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 equiproportionally rationed with compensation being paid for any unserved demand. Consumers post their demands based on their expectations regarding 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 is decreasing in the power price and increasing in the compensation rate, it is increasing when there is a mean-preserving spread in the distribution 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 regarding the supply reliability warrant a higher price compared with a situation of supply adequacy.