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Chapter 11: Q7. (page 449)

Many retail video stores offer two alternative plans for renting films:

鈥� A two-part tariff: Pay an annual membership fee (e.g., \(40) and then pay a small fee for the daily rental of each film (e.g., \)2 per film per day).

鈥� A straight rental fee: Pay no membership fee, but pay a higher daily rental fee (e.g., $4 per film per day).

What is the logic behind the two-part tariff in this case? Why offer the customer a choice of two plans rather than simply a two-part tariff?

Short Answer

Expert verified

The logic behind the two-part tariff is to segregate the consumer into different groups as per their need. The customers are offered two plans rather than simply a two-part tariff because every customer has different needs and generates revenue from each customer.

Step by step solution

01

Step 1. Logic of two-part tariff

The strategy of two-part tariff is used to sort the customer into two groups namely, high-volume group, and low-volume group; suppose the high-volume group rent more than 30 movies per year and low-volume group rents less than 30 movies per year. The problem with the two-part tariff is that the firm faces difficulty deciding the entry and rental fees. Thus, the firm charges two different prices for two different groups of customers.

02

Reason for offering two plans instead of two-part tariff

If the entry fee is high and the rental fee is low, it will benefit the high-volume customer, but it will not benefit the low-volume customers. If the entry fee is low and the rental fee is high, it will benefit the low-volume customer, but it will not benefit the high-volume customers. Hence, the firm keeps both the membership and rent options.

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Most popular questions from this chapter

If the demand for drive-in movies is more elastic for couples than for single individuals, it will be optimal for theaters to charge one admission fee for the driver of the car and an extra fee for passengers. True or false? Explain.

You are an executive for Super Computer, Inc. (SC), which rents out supercomputers. SC receives a fixed rental payment per time period in exchange for the right to unlimited computing at a rate of P cents per second. SC has two types of potential customers of equal number鈥�10 businesses and 10 academic institutions. Each business customer has the demand function Q = 10 - P, where Q is in millions of seconds per month; each academic institution has the demand Q = 8 - P. The marginal cost to SC of additional computing is 2 cents per second, regardless of volume.

  1. Suppose that you could separate business and academic customers. What rental fee and usage fee would you charge each group? What would be your profits?
  2. Suppose you were unable to keep the two types of customers separate and charged a zero rental fee. What usage fee would maximize your profits? What would be your profits?
  3. Suppose you set up one two-part tariff鈥攖hat is, you set one rental and one usage fee that both business and academic customers pay. What usage and rental fees would you set? What would be your profits? Explain why the price would not be equal to marginal cost.

Elizabeth Airlines (EA) flies only one route: Chicago鈥揌onolulu. The demand for each flight is Q = 500 - P. EA鈥檚 cost of running each flight is \(30,000 plus \)100 per passenger.

  1. What is the profit-maximizing price that EA will charge? How many people will be on each flight? What is EA鈥檚 profit for each flight?
  2. EA learns that the fixed costs per flight are in fact \(41,000 instead of \)30,000. Will the airline stay in business for long? Illustrate your answer using a graph of the demand curve that EA faces, EA鈥檚 average cost curve when fixed costs are \(30,000, and EA鈥檚 average cost curve when fixed costs are \)41,000.
  3. Wait! EA finds out that two different types of people fly to Honolulu. Type A consists of business people with a demand of QA = 260 - 0.4P. Type B consists of students whose total demand is QB = 240 - 0.6P. Because the students are easy to spot, EA decides to charge them different prices. Graph each of these demand curves and their horizontal sum. What price does EA charge the students? What price does it charge other customers? How many of each type are on each flight?
  4. What would EA鈥檚 profit be for each flight? Would the airline stay in business? Calculate the consumer surplus of each consumer group. What is the total consumer surplus?
  5. Before EA started price discriminating, how much consumer surplus was the Type A demand getting from air travel to Honolulu? Type B? Why did total consumer surplus decline with price discrimination, even though total quantity sold remained unchanged?

You are selling two goods, 1 and 2, to a market consisting of three consumers with reservation prices as follows:

RESERVATION PRICE (\()

CONSUMER FOR 1 FOR 2

A 20 100

B 60 60

C 100 20

The unit cost of each product is \)30.

a. Compute the optimal prices and profits for (i) selling the goods separately, (ii) pure bundling, and (iii) mixed bundling.

b. Which strategy would be most profitable? Why?

Your firm produces two products, the demands for which are independent. Both products are produced at zero marginal cost. You face four consumers (or groups of consumers) with the following reservation prices:

CONSUMER GOOD 1(\() GOOD 2(\))

A 25 100

B 40 80

C 80 40

D 100 25

a. Consider three alternative pricing strategies: (i) selling the goods separately; (ii) pure bundling; (iii) mixed bundling. For each strategy, determine the optimal prices to be charged and the resulting profits. Which strategy would be best?

b. Now suppose that the production of each good entails a marginal cost of $30. How does this information change your answers to (a)? Why is the optimal strategy now different?
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