A question related to the public good nature of network reliability is whether the fact that something has public good characteristics necessarily implies that it should be provided to all at a uniform level. Again, not necessarily. Imposing a uniform reliability standard to deal with the public good features of networks does disservice to the diverse, heterogeneous preferences that agents have over reliability. A uniform standard is likely to underprovide to high value agents and overprovide to low value agents, and costly inefficiency ensues. Instead, consider the extent to which reliability can be marketed, bought and sold as a differentiated product.
When you want to make a call on your cell phone, is the capacity there to enable you to do so on demand? When you flip the light switch, does the electricity to power the light flow to you on demand? When you want to access a webpage, does your network have the capacity to satisfy your demand in the time that you want it to?
Note that I phrased the third of those examples slightly differently, a rhetorical intention on my part. Intuitively the Internet makes grasping one of the two points of this argument easier – different agents on a network have different preferences over the degree of reliability of the network on which they operate. If I’m a high demand user, I’m more likely to pay for screamin’ broadband capacity coming into my house, signaling to my ISP that they should similarly invest in network capacity to meet the level of reliability that I’ve contracted for with them. If I’m a low demand user, I’ll stick with dialup and the slow connection, and will pay a correspondingly lower price. However, note that in this example, both the high demand and the low demand agent want on-demand access. In Internet networks the measure of reliability is more about upload and download speed than it is about on-demand availability of the network. I think you can make a similar argument about cell phone network reliability – how long does it take to connect your call? And do you stay connected or get dropped? Some people would be willing to pay more for service that connects more quickly and stays connected more reliably. Others may not.
The case of electricity is slightly different, because of the nature of electrons and those pesky laws of physics. In the case of electricity, thinking about reliability essentially boils down to thinking about the probability of interruption, with no issue of connection speed. In this way electric network reliability is similar to, and different from, Internet and cell phone network reliability.
Let’s measure reliability as the probability of receiving service (which is 1-(probability of service interruption)). Ensuring a particular level of reliability and a commensurate probability of receiving service requires investing in network capacity. Now introduce two other features to this narrative model. First, take the important starting point from my previous post: assume that agents have heterogeneous preferences over reliability. For simplicity, as before, think of there being high value agents and low value agents [n.b. For you techie pedants out there, this idea can generalize to a continuum of preferences, very much like is done in discrete and continuous models of product differentiation in Hotelling-style models.]. Second, note that current flow monitoring and interruption technologies have become increasingly available and affordable, which make it feasible to implement the delivery of different levels of reliability to different agents.
In such an environment, treating reliability as a differentiated product becomes feasible, and may even be preferable to the extent that it enables increased value creation through better meeting the diverse preferences of network agents. Note that even in the current regulatory environment, high value agents can buy more reliability – even single-family households can install UPSs (uninterruptible power supply) to power their computers in the case of a blackout. But there’s an asymmetry, in that it’s difficult for low value agents to pay less and buy less reliability than is provided under a uniform standard. That’s where the idea of priority insurance comes in.
When something is scarce, priority insurance is a way for suppliers to ration the scarce resources among customers who have essentially bought a place in line. Think of priority insurance as a menu of contracts where customers choose a price and a probability of service. Put another way, if you are willing to be interrupted, you may pay a lower price, and if there is deficient supply, you will have a lower priority for being served than others who were willing to pay a higher price.
A fantastic discussion of priority insurance is in an article by Hung-Po Chao and Robert Wilson (“Priority Service: Pricing, Investment, and Market Organization,” American Economic Review 77 (December 1987)). Chao and Wilson summarize the idea of priority insurance as
Each customer’s selection of one contract from the menu determines the customer’s service order or priority. In each contingency, the seller rations supplies by serving customers in order of their selected priorities until the supply is exhausted or all customers are served.
Chao and Wilson then go on to point out that priority insurance means that the product being sold can be a differentiated product, differentiated on the dimension of your willingness to be interrupted. Put another way, priority insurance in electric networks makes reliability a differentiated product, not a uniform product that has to be provided to all agents on the network at the same level. Priority insurance empowers agents on a network to choose either higher or lower levels of reliability, depending on their willingness to pay.
Note also that priority insurance provides a means of inducing customers to reveal information about their preferences over reliability. This kind of information is extremely absent today, and its absence means that policymakers have little or no idea of how customers really value reliability. Thus policymakers are making decisions about reliability policy on electric networks without having any good idea about what “the right” level of reliability is, or how costly it is to impose a single level of reliability in the face of diverse agent preferences over the level of reliability.