Bounded Rationality in Service Systems

Abstract

T he traditional operations management and queueing literature typically assumes that customers are fully rational. In contrast, in this paper we study canonical service models with boundedly rational customers. We capture bounded rationality using a model in which customers are incapable of accurately estimating their expected waiting time. We investigate the impact of bounded rationality from both a profit-maximizing firm's perspective and a social planner's perspective. For visible queues with the optimal price, bounded rationality results in revenue and welfare loss; with a fixed price, bounded rationality can lead to strict social welfare improvement. For invisible queues, bounded rationality benefits the firm when its level is sufficiently high. Ignoring bounded rationality, when present yet small, can result in significant revenue and welfare loss.

Price and capacity decisions of service systems with boundedly rational customers

“…The parameter measures the level of customers’ bounded rationality. According to Huang et al (), a larger value of represents a higher level of bounded rationality.…”

“…According to Stidham () and Dewan and Mendelson (), price is a short‐term decision, whereas capacity is treated as a long‐term decision. The short‐ and long‐term decisions in a service system with boundedly rational customers have been studied by Huang, Allon, and Bassamboo () and Li, Guo and Lian (), respectively. Specifically, Huang et al () study the equilibrium queueing decision for boundedly rational customers and, based on that decision, characterize the optimal price for a monopolist; Li et al () study the optimal service rate decision for general types of services, including both customer‐intensive and regular services.…”

“…The short‐ and long‐term decisions in a service system with boundedly rational customers have been studied by Huang, Allon, and Bassamboo () and Li, Guo and Lian (), respectively. Specifically, Huang et al () study the equilibrium queueing decision for boundedly rational customers and, based on that decision, characterize the optimal price for a monopolist; Li et al () study the optimal service rate decision for general types of services, including both customer‐intensive and regular services. However, neither study considered price and capacity decisions jointly and, thus, their work individually cannot resolve the service sustainability issue.…”

“…In addition to the two studies mentioned above (ie, Huang et al and Li et al ), several works study similar customer behavior attributable to limited information about product quality. A group of studies examine customer herding behavior caused by limited information on service quality; see Afèche, Baron, and Kerner (), Cui and Veeraraghavan (), Debo and Veeraraghavan () and Kremer and Debo ().…”

Strategic Capacity Management When Customers Have Boundedly Rational Expectations

“…This is analogous to the interpretation of the level of bounded rationality β in Huang et al. () where β is not controlled by the customers themselves (but may be influenced by the firm).…”