414 PART • Market Structure and Competitive Strategy 11.4 The Two-Part Tariff • two-part tariff Form of pricing in which consumers are charged both an entry and a usage fee The two-part tariff is related to price discrimination and provides another means of extracting consumer surplus It requires consumers to pay a fee up front for the right to buy a product Consumers then pay an additional fee for each unit of the product they wish to consume The classic example of this strategy is an amusement park.12 You pay an admission fee to enter, and you also pay a certain amount for each ride The owner of the park must decide whether to charge a high entrance fee and a low price for the rides or, alternatively, to admit people for free but charge high prices for the rides The two-part tariff has been applied in many settings: tennis and golf clubs (you pay an annual membership fee plus a fee for each use of a court or round of golf); the rental of large mainframe computers (a flat monthly fee plus a fee for each unit of processing time consumed); telephone service (a monthly hook-up fee plus a fee for minutes of usage) The strategy also applies to the sale of products like safety razors (you pay for the razor, which lets you consume the blades that fit that brand of razor) The problem for the firm is how to set the entry fee (which we denote by T) versus the usage fee (which we denote by P) Assuming that the firm has some market power, should it set a high entry fee and low usage fee, or vice versa? To solve this problem, we need to understand the basic principles involved SINGLE CONSUMER Let’s begin with the artificial but simple case illustrated in Figure 11.9 Suppose there is only one consumer in the market (or many consumers with identical demand curves) Suppose also that the firm knows this consumer’s demand curve Now, remember that the firm wants to capture as much consumer surplus as possible In this case, the solution is straightforward: Set the usage fee P equal to marginal cost and the entry fee T equal to the total consumer surplus for each consumer Thus, the consumer pays T* (or a bit less) to use the product, and P* ϭ MC per unit consumed With the fees set in this way, the firm captures all the consumer surplus as its profit $/Q T* F IGURE 11.9 TWO-PART TARIFF WITH A SINGLE CONSUMER The consumer has demand curve D The firm maximizes profit by setting usage fee P equal to marginal cost and entry fee T* equal to the entire surplus of the consumer P* MC D Quantity 12 This pricing strategy was first analyzed by Walter Oi, “A Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse Monopoly,” Quarterly Journal of Economics (February 1971): 77–96