An economic analysis of reliability-constrained service systems

This dissertation considers the problem of a welfare-maximizing monopolist, which must set prices and service quality levels so as to maximize a social welfare function. Demand for the services in question is stochastic and service quality levels are defined in terms of meeting pre-specified service standards at a given level of reliability. The monopolist may face further constraints, including a minimum profit level constraint. General results derived have a close resemblance to received theory for other public service systems. In particular, optimal prices are based on marginal costs, but the marginal costs at issue here are those corresponding to the reliability-constrained expected minimum cost of the system. Optimal reliability levels are also characterized by the requirement that reliability for each service offered be set to equate the marginal benefits to consumers to the marginal cost of the monopolist. The general results are applied to two important areas of public service: postal service and pay-for-service-tollway and bridge use. Both of these services exhibit stochastic demand and important consumer benefits from service quality related to speed of service. In both areas, public policy has at least implicitly also recognized the importance of service standards and reliability constraints. This dissertation contributes to the understanding of the efficient operation of these services by developing an explicit framework for pricing, capacity and reliability choices. In the context of toll-plazas, this study also includes an extended application to the theoretical results obtained to one of the most highly congested barrier toll-plazas on the New Jersey Garden State Parkway. The contributions of this dissertation are primarily the extension of previous analyses of efficient pricing and capacity decisions for public services to allow for explicit reliability constraints, jointly determined with capacity and pricing decisions, where consumer welfare is explicitly dependent not only on price, but also on the quality of service offerings.