We have elsewhere described a scheme for efficient pricing of the congestion costs ([MacKie-Mason and Varian1995b], [MacKie-Mason and Varian1995a]). The basic problem is that when the network is near capacity, a user's incremental packet imposes costs on other users in the form of delay or dropped packets. Our scheme for internalizing this cost is to impose a congestion price on usage that is determined by a real-time Vickrey auction. Following the terminology of Vernon Smith and Charles Plott, we call this a ``smart market.''
The basic idea is simple. Much of the time the network is uncongested, and the price for usage should be zero. When the network is congested, packets are queued and delayed. The current queuing scheme is FIFO. We propose instead that packets should be prioritized based on the value that the user puts on getting the packet through quickly. To do this, each user assigns her packets a bid measuring her willingness-to-pay for immediate servicing. At congested routers, packets are prioritized based on bids. In order to make the scheme incentive-compatible, users are not charged the price they bid, but rather are charged the bid of the lowest priority packet that is admitted to the network. It is well-known that this mechanism provides the right incentives for truthful revelation.
This scheme has a number of nice features. In particular, not only
do those with the highest cost of delay get served first, but the
prices also send the right signals for capacity expansion in a
competitive market for network services. If all of the congestion
revenues are reinvested in new capacity, then capacity will be
expanded to the point where its marginal value is equal to its
marginal cost.