Optimal two-part tariffs for a monopoly firm

Abstract

Recent developments in the telecommunications industry have generated a new interest in the subject of two-part tariffs as an alternative means of pricing telephone calls at the local level. The standard two-part tariff, composed of a fixed charge which buys the consumer the right to purchase some good, and a marginal charge assessed per unit of the good purchased, have traditionally been discussed in terms of pricing subscription to the telephone system and individual calls. This dissertation considers the implications of applying two-part pricing only to actual calls. If such pricing were instituted, the fixed portion of the tariff would be assessed for the connection of the call and the variable charge would be levied on the length of the call. A monopoly telephone firm is modelled in a queueing theory framework under modified assumptions. It is assumed consumers partially control service rates at the firm. It is demonstrated that under this assumption, the probability a potential user can enter service, defined as expected reliability, is co-determined by the firm through its choice of capacity, and by consumers through their choice of number of calls and call lengths. The dissertation further deviates from standard queueing theory by assuming the length of time in service is a good for which the consumer is willing to pay. It is a condition of the model that full price matters to consumers; the total fixed cost of making a call has both monetary and non-monetary portions. The structure of the relationship between the demand for calls and the demand for length per call is examined under the full price conditions. The dissertation concludes by examining the profit maximizing conditions for the monopolist under the demand and supply conditions peculiar to the model developed. The relationship between the monetary portions of the full price of a call and the marginal cost of a call to the firm is examined as the firm chooses across the price space. It is shown that the firm can extract higher profits for a given level of demand by increasing reliability simultaneously with the fixed portion of the two-part tariff.