Approximating a solution to the two-part tariff problem

Abstract

The problem of setting the reservation price in terms of a two-part tariff requires, subject to new prices, reducing the difference between minimum expenditure for the starting level of utility and nominal consumer income. This difference in expenditure can be translated into the area below a compensated demand curve. The compensated demand curve is not directly observable, so the reservation price in this paper is approximated by a change in the consumer surplus. For the case of heterogeneous consumers, a number of reservation prices exist. This paper will address error estimation in setting prices of a capital good and a service. The results obtained are demonstrated using a numerical example.

Keywords

• two-part tariff
• reservation price
• heterogeneous consumers
• error estimation