Nonlinear pricing
The 3 options reviewed under
the heading of the regulatory
dilemma can be described as
linear pricing in so far as
customers pay a single price per
unit of service irrespective of
the volume or intensity of use.
So expenditure is a linear
function of use of the service.
2 part tariff
A two-part tariff is nonlinear and consists of a fixed
amount or fee (i.e., it does not vary with the level of
consumption) plus a per unit charge for the service.
 If the per unit charge is equal to marginal cost, then
it is possible to have socially efficient pricing and
give a fair rate of return to the regulated firm.
Audio explanation (wav)
D = AR
J
0.12
0.10
0
K
LAC
LMC
20,000
KWHs
Example
Let F be the Fixed Fee imposed on electric utility
customers and R is the rate per KWH. Thus, the
utility bill of customer X is given by:
Utility BillX = F + (R • KWHsX)
Notice from the graph that the per unit loss
under the marginal cost pricing option is $0.02.
Therefore:
Total Losses = $0.02 • 20,000 MWHs = $400.00
Let F = k/n, where k is total losses under a marginal
cost pricing regime and n is the number of customers.
If n = 20, then:
F = $400/20 = $20.00
So every customer will pay a fixed fee of $20.00,
regardless of electricity use.
Thus the utility bill of customer X is given by:
Utility BillX = $20.00 + ($0.10 • KWHsX)
If no consumer is "excluded" from
the market by the fixed fee, then
total market expenditure (TE) is
equal to total cost (TC):
TE = $400 + [($0.10)(20,000)] = $2,400
Final notes on 2-part tariffs
The problem with nonlinear pricing is that the fixed
fee may have the effect of pushing the actual or
"effective" price per KWH above the reservation price
for some users--especially small or low-income users.
Hear audio explanation (wav).
If the fixed fee is exclusionary, then the nonlinear
pricing schedule does not measure up to marginal cost
pricing on efficiency grounds.
Multipart tariff
Multipart tariffs (or
declining block pricing)
are widely used among
regulated firms. Under a
multipart tariff, price per
unit of service falls in
blocks as usage
increases.
Multipart tariff for local phone service
Phone Bill ($)
20
C
D
B
10
5
0
A
100
200
Calls/Month
Notes on figure
Customers pay a fixed fee per month = $5.00
+ $0.10 per call for calls up to 100
+ $0.05 per call for calls between 100 and 200
+ $0.00 per call for all calls above 200
 If you make 100 calls, your phone bill is $15.00.
If you make 200 calls, you bill is $20.00.
If you make 300 calls, you bill is $20.00.
Total expenditure function is given by
TE = ABCD
Hence the function is nonlinear.
Why is a multipart tariff a good
idea?
Distribution of telephone
service, e.g., is subject to
economies of scale.
Diminishing prices at the
margin stimulate
consumption, which in turn
permits the construction of
large scale capacity.
Back to Lesson 11