Monopoly II: Two-part tariff

A two-part tariff is a price discrimination technique that consists in charging consumers with a lump sum fee for the right to purchase the product and then a price per unit consumed. This practice is specially used in places such as golf clubs and amusement parks.

The firm must set the enrolment fee and the price per-unit of the product that maximises its profit. To maximise the amount of product purchased by consumers the firm must set a price that is equal to the marginal cost. Subsequently, the firm will appropriate consumer surplus by setting a fixed fee, A. The first tariff would be the entrance fee, A, which allows the monopoly to extract all consumer surplus.  The second tariff is the price per unit, p*q, being this price equal to marginal cost, which means that there is no surplus, since the surplus cannot be extracted twice.

As it can be seen in the figure below, which shows two different demand curves for two types of consumers who have different willingness to pay, there are different ways to implement a two-part tariff. Monopolies can charge different entrance fee for each consumer according to their willingness to pay, extracting all the consumer surplus (grey area). However, since this is quite the same as first-degree price discrimination, it is hard to implement. When monopolies are unable to distinguish between different types of consumers, they can charge an entrance fee high enough so only the more exclusive, more willing to pay consumers get the product (green). The monopoly will extract all the consumer surplus of the first type of consumer, but won’t sell at all to the second type. Finally, the monopoly can charge the same entrance fee to both types, but that entrance fee will be that of the less willing consumer, A₂, charging the same to the other consumer, A₁ (blue). As it can be seen, in this case the monopoly will be able to extract more total consumer surplus by increasing prices from p to p’: it will extract less from the second type of consumer (area -) but will extract even more from the first type of consumer (area +).