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5 B A Monopoly =7 price Profits = $12 C D MC = AC 3 0 3 MR 10 Q Source: Based on microeconomic theory Now suppose Costco Club’s demand and cost curves do not change. which is represented by the shaded rectangle ABCD. Illustration of two-part pricing strategy Suppose consumer demand function of Costco Club is Q = 10 – P and the cost function is C(Q) = 3Q as demonstrated in figure 1. In other words.5 allowing the customers to access into the club. Definition Two-part pricing is a pricing strategy where consumers are charged a fixed fee for the right to purchase a product. This corresponds to the point where marginal revenue equals marginal cost. Two-part pricing strategy 1. this kind of price consists of two components: first.1. 1. a per-unit charge.1. the consumer surplus of all consumers in the market is the triangle ABE. Additionally.1. Costco Club gets the profit of $12. This means that the consumers receive the value of $4. . it charges $2 for each time they use the gym facilities. plus an additional per-unit charge for each unit of product purchased.1 below. If this club charge a simply single price for all customers.1.2 from 3 units that they did not pay for. a lumpsum fee. Figure 1. Brief explanation 1. Standard monopoly pricing P 10 E Consumer surplus = $4. With this price-quantity combination.2. the profit – maximizing level of output would be Q = 3 and the profit – maximizing price would be P = 7. but the club change its pricing strategy that it charges all of its consumers an annual membership fee of $24. and second. which values $4. Moreover.

. it is clearly summarized that the two-part pricing can be conducted through three steps: . the club has a per-unit charge of $3. with two-part pricing strategy.2. . which is equals to the marginal cost of the club showing that Costco Club makes no profit on each unit sold.5 from all consumers. From the demonstration of Costco Club. the club still makes profit from charging a fixed membership fee of $24. In this case.5 = profits D C MC = AC 3 0 7 10 Q Source: Based on two-part pricing principle This situation is graphed in figure 1.2.Charge a fixed fee equals to consumer surplus. the consumers will purchase 7 units and receive a consumer surplus of $24. In other words.3 Figure 1. Costco Club would be able to extract the entire consumer surplus from it consumers.5. Two – part pricing demonstration P 10 E Consumer surplus = 0 Fixed fee = $24. . Moreover.Set price at marginal cost.Compute consumer surplus. However.

because this is the only price at which Qc units can be sold. Pc. 1.4 With this pricing strategy. consumer surplus: to the light blue area A.2. it would charge price Pm per unit and supply Qm  maximizing profit but producing below the allocatively efficient level of output Qc.  Economic profit for the firm: the green area B. . If the firm is a price discriminating monopolist. If there are multiple consumers with homogeneous demand.There are two consumers. X and Y. the firm can extract additional surplus from the consumers and enhance its profits simultaneously. where n is the number of consumers. Two-part pricing when consumer demand is homogeneous - When consumers have homogeneous demand.2.2. any one consumer is representative of the - market (the market being n identical consumers) If the firm is perfectly competitive. Consumer Y's demand is exactly twice consumer X's demand. Further problems 1. ABC.1. the firm must charge the perfectly competitive price per unit. then profit will equal n times the area ABC. it would charge price P c and supply Qc to our consumer  no economic profit but producing an allocatively efficient output .2.If the firm is a non-price discriminating monopolist. 1. Two-part pricing when consumer demand is different . - a deadweight loss: the purple area C. the firm then imposes a fee upon our consumer equal to her consumer surplus. To make up for the lower cost per unit.

where producers charge a lump sum to a retailer for the right to carry their products plus a constant charge per unit ordered by the retailer. it is the matter of market power and type of commodities that the firm needs to consider when applying two-part pricing strategy.A solution to pricing consumer X out of the market is equal to charge P c per unit.the largest consumer surplus of the two consumers  The firm will be pricing consumer X out of the market . The firm’s customers may have either identical or different demand curves. .5 - The firm would like to follow the same logic as before and charge a per-unit price of P c while imposing a lump-sum fee equal to area ABCD . oligopoly and monopoly.The firm has market power. because the firm. 1. Market power or market structure Firm having two following conditions should utilize two-part pricing strategy: . bookstores. This strategy tends to work best when consumer demand is relatively homogeneous. Particularly. needs to narrow the target market.3. telephone services and access to website information. in order to set the appropriate per-unit charge for each group of consumers. including three specifice types of power: monopolitic - competition. there are several examples of two–part pricing strategy used in amusement parks.1. if it wants to enhance the profits efficiently. It can be said that two-part pricing is also used in those markets.3. Application 1. Profit in this instance equals twice the area AC (two consumers): 2 x AC=ABCD  The profit is the same and the producer is indifferent to either of these pricing - possibilities It can be seen that applying two-part pricing in doing business may arise the risk of increasing administrative and management costs. museums. In practice.

which uses the film made exclusively by Polaroid. which specifies a fixed fee and a royalty for each unit produced. This means that the perunit price of each individual ride is the same for all visitors. the price of film would be close to marginal cost. However. where Disneyland can still enhance its profits. it is able to set two different prices. which can be produced by any other firms. the optimal strategy is to sell rides at the price equated to marginal cost. The articles concerning this pricing strategy argued that it was necessary for Polaroid to have monopoly for two reasons: first. However. In the end. Block pricing 2. second.1. Brief explanation 2. With this product.3. Polaroid Corporation needed to make most of its profits from the sale of film.1. Applying the two-part pricing strategy. 2. 1. Definition . Real life examples Disneyland’s admission fee This is a classic example of two-part pricing strategy. It can be seen that buying the camera is like the entrance ticket of Disneyland. two-part pricing can also be seen in several technology licensing agreements.6 Recently. the film’s price was significantly above marginal cost and there was considerable heterogeneity of consumer demands. which allows the consumers to buy and use the film and camera.2. when considering all visitors are identical. Polaroid used two-part pricing strategy for pricing of camera and film. This allowed them to create greater profits than it would have been possible if camera used ordinary film. if Polaroid camera could work with ordinary film. which was analyzed in the article written by Walter Oi in 1971. Disneyland is said to maximize it profits by setting prices for admission to the theme park and for individual rides. the marginal cost of providing an additional camera is considerably higher than zero. In case that the consumers’ tastes are different and the park’s management board can realize the relation in the population between rides demanded and consumer surplus. each visitor would be charged a different fixed admission fee that converts his entire consumer surplus into Disneyland’s profits. when launching Polaroid camera.1. Polaroid camera and Polaroid film Polaroid Corporation introduced its SX-70 instant camera. unlike the theme park.

1 x 8 = 1.2 per roll and sell Q=4 rolls per buyer.7 Block pricing is the practice of charging different prices for different amount or block of a good service.1. The supermarket's per customer operation profit is TR – TVC = 0.2. The idea behind block pricing is to charge a package price that includes some consumer surplus. equate price in P= 0.4 greater than the operating profit when selling paper rolls one at a time. the optimal number of paper rolls per package is Q=8. To maximize profit.1) 8 + 0. 2.3 – 0. such as selling a package of eight paper rolls or a six-pack of beer. suppose the manager adopts a block pricing strategy by selling multiple paper rolls in a package. In this example.5(0.3 .6 The supermarket’s operating profit equals consumer surplus of TR – TVC= 1.0.1 below.05Q Since MC=0.1.025Q to marginal cost. the price per package is TR=0. The inverse demand equation of a typical customer is P = 0.6 0. Block pricing . The price charge per package equals to the total value received by the buyer. the manager should charge a price such that MR=MC.8 which is 0. Solving. which is equal to the sum of consumer surplus and total variable cost. Illustration of block pricing strategy To illustrate the ideas behind block pricing.4 Now.1 $ each. To determine the number of paper rolls in each package.3 – 0. The supermarket's marginal revenue equation is MR = 0. How many rolls should be included in the package. Figure 2.1.025Q Suppose the manager adopts a one-price strategy.8 = 0. which is given by the shaded area in the figure. suppose that the manager of a supermarket purchase paper rolls from a distributor for 0. the supermarket should charge P=0. and at what price? What is the supermarket's per customer operating profit? The answers to this question are illustrated in Figure 2.3 – 0.

if the price for the package is higher than the acceptable value for consumers.3. Some real-life examples which can be easily recognized are supermarkets. Comparison between two strategies Benefit Two-part pricing Blocking pricing Allow firms to gain larger profits than they normally would at the monopoly price The firms extract more of the consumer surplus by The firms extract the maximum charging a fixed fee equal to the total consumer consumer surplus by forcing surplus and set per-unit fee equal to marginal cost consumers to make an all-or- .2. block pricing can be effective where price discrimination would fail. Furthermore. grocery stores… 3. Further problems Block pricing poses an “all-or-nothing” situation for consumers. However.2. Relationship between block pricing and value consumers receive 2.8 P 0. Application Market with somewhat standardized and necessary products such as toilet papers. Figure 2. they can stop buying all together. instant noodles.1 0 MR 4 8 10 Q 2.2 MC 0.

markets. including amusement For instance. the most value out of the discount shopping or other clubs. Block pricing is frequently retail parks. consumer to buy the large pack One reason to set a two-part price is to cover some or not to buy the pack at all. in February 2011. earn a larger profit. An example is a services. museums. used by supermarkets to extract various types of sports.9 to ensure that the surplus is as large as possible. none decisions to get the full total value of the products they Environment There are several examples of two-part tariffs in receive. .72 cents per 60 seconds.86 to 1. of toilet paper. the supermarket can line rental. and access to website information. where manufactures charge a lump sum will bundle the toilet paper into to a retailer for the right to carry their product plus units of 24 or 48 to force the a constant charge per unit ordered by the retailer. By customer-specific fixed cost. bookstores.43 for three months plus a usage charge of 0. telephone consumers. Singapore Telecom’s rate for a residential fixed line was S$29. depending on the time of day. such as the cost of packaging the toilet paper in connection in telecommunications or the cost of this way. package Two-part pricing are also often used in wholesale Oftentimes the supermarkets markets.