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Chapter 11: Problem 7

Many retail video stores offer two alternative plans for renting films: 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). 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 two-part tariff is typically more appealing to frequent users who can offset the annual membership fee through frequent rentals, while the straight rental fee is more suitable for infrequent users who do not want to pay an upfront fee. By offering both, the business aims to cater to a wider customer base and maximize their potential revenue.

Step by step solution

01

Explain the Two-Part Tariff

A two-part tariff model in this context involves an annual membership fee, and then a smaller fee per film per day. This model is marketed towards customers who frequently rent films. It becomes cost-effective for customers who might rent more than 20 films a year as the annual fee (e.g., $40) would be compensated by the smaller daily rental fee (e.g., $2 per film per day).
02

Explain the Straight Rental Fee

The straight rental fee model is a no-commitment, pay-per-use system. Customers do not pay any membership fee, but pay a higher fee per film per day (e.g., $4). This model caters to infrequent users or customers who do not want to or cannot afford to pay an upfront membership fee. This can also attract customers who might have irregular or unpredictable usage patterns.
03

Logic Behind Offering Both Plans

Offering both plans allows the business to cater to different types of customers and maximize their market penetration. The two-part tariff can attract frequent users and guarantee a steady revenue from the membership fees. The straight rental fee can attract infrequent or sporadic users who do not want to commit to a membership. This dual approach can potentially cater to a wider customer base, and hence, drive higher revenue for the business.

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Most popular questions from this chapter

A monopolist is deciding how to allocate output between two geographically separated markets (East Coast and Midwest), Demand and marginal revenue for the two markets are $$\begin{array}{ll}P_{1}=15-Q_{1} & \mathrm{MR}_{1}=15-2 Q_{1} \\ P_{2}=25-2 Q_{2} & \mathrm{MR}_{2}=25-4 Q_{2}\end{array}$$ The monopolist's total cost is \(C=5+3\left(Q_{1}+Q_{2}\right)\) What are price, output, profits, marginal revenues, and deadweight loss (i) if the monopolist can price discriminate? (ii) if the law prohibits charging different prices in the two regions?

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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.

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and arbitrage: a. Requiring airline travelers to spend at least one Saturday night away from home to qualify for a low fare. b. Insisting on delivering cement to buyers and basing prices on buyers' locations. c. Selling food processors along with coupons that can be sent to the manufacturer for a \(\$ 10\) rebate. d. Offering temporary price cuts on bathroom tissue. e. Charging high-income patients more than lowincome patients for plastic surgery.

You are an executive for Super Computer, Inc. (SC), which rents out super computers. 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-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 \(\mathrm{SC}\) of additional computing is 2 cents per second, regardless of volume. a. 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? b. 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? c. Suppose you set up one two-part tariff-that 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 price would not be equal to marginal cost.
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