Optimal Contract Period for Priority Service

In industries with capacity constraints and nonstorable outputs, priority service is a form of market organization in which customers subscribe in advance to the order in which they will be served from scarce supplies. The optimal duration of priority service contracts depends on a tradeoff between transaction costs and efficiency gains that, in turn, depends on the serial correlations of customers' service valuations. Using a stationary Markov process to characterize the distribution of customers' valuations, we present several simple methods that illustrate the principal determinants of the optimal contract period.