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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

Sal鈥檚 satellite company broadcasts TV to subscribers in Los Angeles and New York. The demand functions for each of these two groups are

QNY = 60 - 0.25PNY

QLA = 100 - 0.50PLA

where Q is in thousands of subscriptions per year and P is the subscription price per year. The cost of providing Q units of service is given by

C = 1000 + 40Q

where Q = QNY + QLA.

  1. What are the profit-maximizing prices and quantities for the New York and Los Angeles markets?
  2. As a consequence of a new satellite that the Pentagon recently deployed, people in Los Angeles receive Sal鈥檚 New York broadcasts and people in New York receive Sal鈥檚 Los Angeles broadcasts. As a result, anyone in New York or Los Angeles can receive Sal鈥檚 broadcasts by subscribing in either city. Thus Sal can charge only a single price. What price should he charge, and what quantities will he sell in New York and Los Angeles?
  3. In which of the above situations, (a) or (b), is Sal better off? In terms of consumer surplus, which situation do people in New York prefer and which do people in Los Angeles prefer? Why?

Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to \(20,000 and a fixed cost of \)10 billion. You are asked to advise the CEO as to what prices and quantities BMW should set for sales in Europe and in the United States. The demand for BMWs in each market is given by

QE = 4,000,000 - 100PE

and

QU = 1,000,000 - 20PU

where the subscript E denotes Europe, the subscript U denotes the United States. Assume that BMW can restrict U.S. sales to authorized BMW dealers only.

  1. What quantity of BMWs should the firm sell in each market, and what should the price be in each market? What should the total profit be?
  2. If BMW were forced to charge the same price in each market, what would be the quantity sold in each market, the equilibrium price, and the company鈥檚 profit?

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.

As the owner of the only tennis club in an isolated wealthy community, you must decide on membership dues and fees for court time. There are two types of tennis players. 鈥淪erious鈥� players have demand

Q1 - 10 - P

where Q1 is court hours per week and P is the fee per hour for each individual player. There are also 鈥渙ccasional鈥� players with demand

Q2 = 4 - 0.25P

Assume that there are 1000 players of each type. Because you have plenty of courts, the marginal cost of court time is zero. You have fixed costs of $10,000 per week. Serious and occasional players look alike, so you must charge them the same prices.

  1. Suppose that to maintain a 鈥減rofessional鈥� atmosphere, you want to limit membership to serious players. How should you set the annual membership dues and court fees (assume 52 weeks per year) to maximize profits, keeping in mind the constraint that only serious players choose to join? What would profits be (per week)?
  2. A friend tells you that you could make greater profits by encouraging both types of players to join. Is your friend right? What annual dues and court fees would maximize weekly profits? What would these profits be?
  3. Suppose that over the years, young, upwardly mobile professionals move to your community, all of whom are serious players. You believe there are now 3000 serious players and 1000 occasional players. Would it still be profitable to cater to the occasional player? What would be the profit-maximizing annual dues and court fees? What would profits be per week?

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.
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