Two Part Tariff Pricing

Two part-tariff refers to the practice of charging two-part prices by the producer and/ or supplier of a good or services. The term ‘tariff’ stands here for pricing. It can be defined as, “A two-part tariff is one in which the consumer must pay a lump sum fee for the right to buy a product.” It is clear that under two-tariff price system consumers pay a one-time access fee (T) for the right to buy a product, and a per-unit price (P) for each unit they consume. So, the total price for a consumer who pays both entry fee and usage fee will be

R = T + PX
Where, X are units of product or service X consumed/ demanded.

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. In general, price discrimination techniques only appear (take place) in partially or fully monopolistic markets. The main objective of using two part tariff by a firm is to capture more consumer.

A two-part tariff is a strategy of price discrimination by firm to capture maximum amount of consumer surplus. The problem for the firm is how to set the entry fee (membership fee) versus the usage fee. The amount of entry fee (membership fee) charged by firms will be different depending on whether the demand is identical or different. A rational firm will set the per unit usage fee above or equal to the marginal cost of production, and below or equal to the price that a firm would charge in a perfect monopoly. Under a condition of competition the per-unit usage price is set below marginal cost. Basically it is required that the product or service offered by the firm be identical to all consumers so that price charged may not vary due to differences in production costs of the firm.

Assume that the firm has some market power and it is operating under monopoly. Then the question is: should it set a high entry fee and low usage fee, or vice versa? To see how a firm can solve this problem, we need to know the basic principles involved.

In order to maximize total profits a monopolist has to charge a usage fee (or per unit price) equal it its marginal cost and initial/ entry fee (or membership fee) equal to the entire consumer surplus.

Normally the concept of two-part tariff is applicable in monopoly or monopolistic or oligopoly markets. But economists also argue that two-part tariffs may also exist in competitive markets when consumers are uncertain about their ultimate demand.

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