Two-Part Tariff Pricing Strategy

Question

A firm with market power faces a demand curve given by P = 40 – 2Q and a total cost curve given by TC = 8Q. If the firm uses a two-part tariff, what price should it charge its customers? What is the fixed fee that it will charge its customers?

Answer 1

When a firm uses the two-part tariff pricing strategy, the price that the firm charges its customers is equal to the marginal cost. Since TC = 8Q, the marginal cost is given by MC = $8. Thus, the firm should charge $8 for the product.

The fixed fee is equal to the consumer surplus at P = $8.

Since P = 40 – 2Q, we get Q = 20 – (1/2) P

When P = $8, the price the firm charges under the two-part tariff, we have Q = 20 – (1/2) (8) = 16.

The choke price is the price at Q = 0. This is given by the inverse demand curve P = 40 – 2Q. So, choker price is P = $40. Fixed fee = CS = (1/2) (16) ($40 - $8) = $256.