User:Narxysus/TwoPartTariff
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A two-part tariff is a price discrimination technique in which the price of a product or service is composed of two parts - a lump-sum fee as well as a per-unit charge. As with all price discrimination techniques, it may only occur in partially or fully monopolistic markets. It is designed to enable the firm to capture more consumer surplus than it otherwise would in a non-discriminating pricing environment.
Depending on the homogeneity of demand, the lump-sum fee charged varies, but the rational firm will set the per unit charge will be above or equal to the marginal cost of production, and below or equal to the price the firm would charge in a perfect monopoly.
An important element to remember concerning two-part tariffs is that it is still price discrimination, of which an important feature is that the product or service offered by the firm must be identical to all consumers, hence, price charged may vary, but not due to different costs borne by the firm, as this would infer a differentiated product. Thus, while credit cards which charge an annual fee plus a per-transaction fee is a good example of a two-part tariff, a fixed fee charged by a car rental company in addition to a per-kilometre fuel fee is not so good, because the fixed fee may reflect fixed costs such as registration and insurance which the firm must recoup in this manner. This can make the identification of two-part tariffs difficult.
[edit] A two-part tariff when consumer demand is homogeneous
In this example, assume demand is homogeneous across consumers, and there is one firm who experiences constant costs (for simplicity - hence the horizontal marginal cost (MC) line). A perfectly competitive market would charge price Pc and supply Qc, making no economic profit but producing an allocatively efficient output. Without price discrimination, a monopolist would charge price Pm per unit and supply Qm, maximizing profit below the allocatively efficient level of output Qc. This situation yields economic profit for the firm equal to the green area B, consumer surplus equal to the light blue area A, and a deadweight loss equal to the purple area C.
The demand curve represents a consumer’s maximum willingness to pay for any given output. Thus, the consumer is willing to pay their entire surplus (A), as long as they receive the appropriate amount of goods, in this case, Qc. The lump-sum fee therefore equals this surplus, and enables the firm to capture all the consumer surplus and deadweight loss areas, increasing profits. The per-unit charge is equal to the marginal cost of supplying each unit (MC). This situation yields economic profit for the firm equal to the areas ABC, zero consumer surplus, and no deadweight loss.
This results in an allocatively efficient output, one of the redeeming qualities of price discrimination. If there are multiple consumers with homogeneous demand, then profit will equal n times the area ABC, where n is the number of consumers.
[edit] A two-part tariff when consumer demand is different
In this case, there are two consumers, X and Y. Consumer Y's demand is exactly twice consumer X's demand, and each of these consumers is represented by a separate demand curve, and their combined demand (Dmarket). The firm is the same as in the previous example. It is important to note that the firm cannot separately identify each consumer - it cannot therefore price discriminate against each of them individually.
The firm would like to follow the same logic as before and charge a per-unit price of Pc while imposing a lump-sum fee equal to area ABCD - the largest consumer surplus of the two consumers. In so doing, however, the firm will be pricing consumer X out of the market, because the lump-sum fee far exceeds his own consumer surplus of area AC. Nevertheless, this would still yield profit equal ABCD. A solution to pricing consumer X out of the market is to thus charge a lump-sum fee equal to area AC, and continue to charge Pc per unit. Profit in this instance equals twice the area AC (two consumers): since consumer Y's demand is twice consumer X's, then 2 x AC = ABCD. As it turns out, the producer is indifferent to either of these pricing possibilities.
Recall that price discrimination occurs in a partially or fully monopolistic market. This firm therefore has some capacity to set price in the market. Assume it sets the unit price equal to Pm, and imposes a lump-sum fee equal to area A. Now, the firm is making a profit on each unit sold - total market profit from the sale of Qm units is equal to area CDE. Profit from the lump-sum fee is 2 x A = AB. Total profit is therefore area ABCDE.
Thus, by charging a higher per unit price and a lower lump-sum fee, the firm has generated area E more profit than if it had charged a lower per-unit price and a higher lump-sum fee. Note that the firm is no longer producing the allocatively efficient output, and there is a deadweight loss experienced by society equal to area F - this is a result of the exercise of monopoly power.
