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Chapter 11: Q7. (page 449)

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 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

Suppose that two competing firms, A and B, produce a homogeneous good. Both firms have a marginal cost of MC = \(50. Describe what would happen to output and price in each of the following situations if the firms are at (i) Cournot equilibrium, (ii) collusive equilibrium, and (iii) Bertrand equilibrium.

(a) Because Firm A must increase wages, its MC increases to \)80.

(b) The marginal cost of both firms increases.

(c) The demand curve shifts to the right.

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’s profit?

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

P1 = 15 – Q1 MR1 = 15 - 2Q1

P2 = 25 - 2Q2 MR2 = 25 - 4Q2

The monopolist’s total cost is C = 5 + 3(Q1 + Q2). 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?

In Example 11.1 (page 422), we saw how producers of processed foods and related consumer goods use coupons as a means of price discrimination. Although coupons are widely used in the United States, that is not the case in other countries. In Germany, coupons are illegal.

  1. Does prohibiting the use of coupons in Germany make German consumers better off or worse off?

  2. Does prohibiting the use of coupons make German producers better off or worse off?

Some years ago, an article appeared in the New York Times about IBM’s pricing policy. The previous day,IBM had announced major price cuts on most of itssmall and medium-sized computers. The article said:

IBM probably has no choice but to cut prices periodicallyto get its customers to purchase moreand lease less. If they succeed, this could makelife more difficult for IBM’s major competitors.Outright purchases of computers are needed for ever larger IBM revenues and profits, says Morgan Stanley’s Ulric Weil in his new book, InformationSystems in the 80’s. Mr. Weil declares that IBM cannot revert to an emphasis on leasing.

a. Provide a brief but clear argument in support of the claim that IBM should try “to get its customers to purchase more and lease less.”

b. Provide a brief but clear argument against this claim.

c. What factors determine whether leasing or selling is preferable for a company like IBM? Explain briefly.
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