A Two-part Tariff When Consumer Demand Is Homogeneous
When consumers have homogeneous demand, any one consumer is representative of the market (the market being n identical consumers). For purposes of demonstration, consider just one consumer who interacts with one firm which experiences no fixed costs and constant costs per unit - hence the horizontal marginal cost (MC) line.
Recall that the demand curve represents our consumer’s maximum willingness to pay for any given output. Thus, as long as he receives an appropriate amount of goods, such as Qc, then he will be willing to pay his entire surplus (ABC) in addition to the cost per unit under perfect competition (Pc by Qc) - i.e. the entire area under the demand curve up to point Qc.
If the firm is perfectly competitive, it would charge price Pc and supply Qc to our consumer, making no economic profit but producing an allocatively efficient output. If the firm is a non-price discriminating monopolist, it would charge price Pm per unit and supply Qm, maximizing profit but producing below the allocatively efficient level of output Qc. This situation yields economic profit for the firm equal to the green area B, consumer surplus equal to the light blue area A, and a deadweight loss equal to the purple area C.
If the firm is a price discriminating monopolist, then it has the capacity to extract more resources from the consumer. It charges a lump sum fee, as well as a per unit cost. In order to sell the maximum number of units, the firm must charge the perfectly competitive price per unit, Pc, because this is the only price at which Qc units can be sold (note this is also the marginal cost per unit). To make up for the lower cost per unit, the firm then imposes a fee upon our consumer equal to her consumer surplus, ABC.
The lump-sum fee enables the firm to capture all the consumer surplus and deadweight loss areas, resulting in higher profit than a non-price discriminating monopolist could manage. The result is a firm which is in a sense allocatively efficient (price per unit is equal to marginal cost, but total price is not) - one of the redeeming qualities of price discrimination. If there are multiple consumers with homogeneous demand, then profit will equal n times the area ABC, where n is the number of consumers.
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