TWO-PART TARIFFS

Consumer Surplus and How it is Extracted  Using Two-Part Tariffs

Abstract

Consumer Surplus is the difference between the price that a consumer is willing to pay for a good and the amount he actually pays. From another angle, Consumer Surplus is the utility for consumers by being able to purchase a product for a price that is less than the highest price that they would be willing to pay. Conversely, Producer Surplus is the amount that producers benefit by selling at a market price mechanism that is higher than the least that they would be willing to sell for. At some point, no producer surplus accrues to the seller. Economic profit is driven to zero and that item is either taken off the shelf and / or disposed off in ‘Sales Season’. Consumer Surplus is of singular importance in understanding the Microeconomic term “Two-part Tariff’.

Introduction

A number of pricing techniques are used to determine the best returns for a product or service. One example is ‘Premium Pricing’, where you pay an exorbitant sum for brand value or exclusivity of the product, like LMVH, DKNY or Armani dresses.

Another, Penetration Pricing, sees market penetration by an agency by undercutting all competitors at a deliberately set low price, a painful reminder of Chinese dominance of the global apparel market during the ATC (quota) phase and even subsequently.

Barring China, once targeted market density is achieved, the price may be raised in
quick stages to prevailing or slightly higher levels to recover losses incurred and get into the black. Many sellers allow you to repay the cost in installments, at some fixed rate of interest. Consumer Surplus is essentially a form of profit and marketers target it, by using specific pricing methods, one of which is Two-part Tariffs.

Consumer Surplus is the difference between the price that a consumer is willing to pay for a good and the amount he actually pays. From another angle, Consumer Surplus is the utility for consumers by being able to purchase a product for a price that is less than the highest price that they would be willing to pay. Conversely, Producer Surplus is the amount that producers benefit by selling at a market price mechanism that is higher than the least that they would be willing to sell for. At some point, no producer surplus accrues to the seller. Economic profit is driven to zero and that item is either taken off the shelf and / or disposed off in ‘Sales Season’. Consumer Surplus is of singular importance in understanding the Microeconomic term “Two-part Tariff’.

Other Relevant Factors

Pindyk, Rubinfeld and Mehta, in their book: Microeconomics Sixth Edition, define Consumer Surplus as “the difference between the price that a consumer is willing to pay for a good and the amount actually paid” (107). A two-part tariff (TPT) has many interpretations, one of which is: “A form of pricing in which consumers are charged both an entry and a usage fee” (ibid 317). There is more to two-part tariffs than described. It is essential to understand certain associated economic factors before getting at the rather complex topic. In this article, I will explain in brief Consumer Surplus, Demand Curve, Consumer Surplus and Demand, Monopoly and Pricing Strategies with Market Power. Two-part tariffs and consumer surplus are closely linked; I will explain what two-part tariff means in practical terms and show how firms try to extract consumer surplus using it.

Consumer Surplus

The public purchases goods only if there is some benefit to be had. Consumer surplus is a valuation of how much benefit individuals gain as a total on completing their purchase of the product in question. It is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods. Most people have differing methods of evaluating the intrinsic value of a good. Such extraneous factors, apart from purely commercial reasons, decide for these individuals the maximum price they are willing to fork out for an item. If an individual is willing to pay US$ 100 for a pair of Reebok shoes but manages a marked down version for $ 40; his consumer surplus is $60 (Refer definition of consumer surplus).

Demand Curve

The demand curve is a graph depicting the relationship between the price of a
certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. (O'Sullivan and Sheffrin 2003).

 Figure 1

The point at which the demand and supply curves intersect is called the Point of Economic Equilibrium. This is the price at which seller gains optimal profit in a competitive market.  Variations can take place in the market. 

The diagram shows a positive shift in demand from D₁ to D₂, resulting in an increase in price (P) and quantity sold (Q) of the product.

The four basic laws of supply and demand are:

1. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
2. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
3. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
4. If supply decreases and demand remains unchanged, then it leads to higher equilibrium price and lower quantity.

The demand curve for all consumers is projected by simply consolidating individual demands at each price. Demand curves are used to estimate behaviors in competitive markets, and are combined with supply curves to assess the equilibrium price, or market clearing price, where the demand is equal to the supply, depicted as the point where the demand and supply curves meet. Profit margins are optimal at this
point and retailers are free to manipulate prices according to endemic conditions. The
same item can be bought at steep costs in up-market areas and at far more reasonable prices at normal stores. The graph shows how demand tails off rapidly above this price.

The producer continues to makes his profit at any point on the curve, since he works on volume distributed to multiple retailers and the profit margin he has added for the product. His cut-off point is at a much lower price, as seen on Figure 1. Note that the supply curve is close to being a straight line, while the demand curve does actually curve.

Consumer Surplus and Demand

According to Pindyk, Rubinfeld and Mehta, “A demand curve is the relationship between the quantity of a good consumers are willing to buy and the price of that good” (ibid, 18). They add, “It is fairly simple to calculate consumer surplus if the corresponding demand curve is known and their relationship can be examined” (ibid, 107). Let us do so for an individual, as advised by the authors.

In the stated example, the consumer could muster $100 for his pair of Reebok shoes. Let us assume he has four family members and a close friend who would also like to buy those shoes. Utilising his consumer surplus of $60, he could get them, who have available resources of $75-$80, to also buy the said shoes (refer Figure 2). With each buy, the consumer surplus keeps increasing, till at one stage it reaches a total of say, $100. Assume that his friend can afford only $20. He can now give $20 to his friend and then buy two more pairs as gifts for other friends. In effect, he and his coterie kept buying shoes as they were being subsidised by consumer surpluses. They ultimately bought eight pairs of shoes @ $40 each, at one time having an overall consumer surplus of $100, all of which went back into more shoes. Note that they wanted to buy the shoes. If the buyer was satisfied with only two pairs, he would retain some surplus funds. It is this consumer surplus that the two-part tariff attacks.

Figure 2

Monopoly

Before we get to monopoly, it would be prudent to understand the working of a ‘perfectly competitive market’. According to Sen (159), “A perfectly competitive market is an intensely competitive market where firms sell homogenous products. The outputs of all firms are identical from the standpoint of buyers.” Moreover, “The number of buyers and sellers in the market is large; the actions of one agency will have little or no bearing on trading and all agents have perfect information” (ibid).

The other extreme is where one firm rules the roost, with no competition. “Such an industry is called a monopoly” (ibid 180). In effect, a monopolist sets all prices since he has no competition. His predatory pricing leaves little room for consumer surplus, absorbing it almost fully as additional profit. The Polaroid camera is one example.

Pricing Strategies with Market Power

So far we have assumed that the monopolist charges a flat rate. If he can charge different customers different rates for the same product, he gets a chance to make a greater profit. In an upscale market, he charges his customers the maximum he can extract from them. The same price will be prohibitive in a low-brow market. In this market, he charges a lower price, but still the highest he can extract from the less affluent customers. This is a simple example of price discrimination. According to Sen, three conditions must be met to ‘price discriminate’ successfully (202). These are:

1. The firm has market power. A perfectly competitive firm can never ‘price discriminate’.
2. The firm must be able to separate buyers into groups which can be charged different rates.
3. The firm must be able to prevent arbitrage. Low cost buyers should not be able to sell their purchases in upscale markets.

There are various types and degrees of price discrimination. These, however, fall outside the purview of this paper. What needs to be noted is that their basic aim is the same: to extract the maximum consumer surplus.

The Two-part Tariff

Pindyk, Rubinfeld and Mehta state, “The two-part tariff is related to price discrimination and provides another means of extracting consumer surplus” (317). All consumers pay cash down to buy a base product. They then pay extra for each section of the good they intend to use. Discotheques charge two-part tariffs with gay abandon. Entry is at a moderate cost, conditional to buying a minimum of two drinks at the bar. Each drink costs the same, whether it is a soda or beer, and is a rip-off. “All clubs that have members charge two-part tariffs: Annual membership fee plus facility usage fee” (ibid). The Dutch firm Makros is an example where apparel is considered. The stores are open only to paid registered members to gain entry to the store. Unit costs inside are very low, when compared to ruling market prices. A number of online stores also come into this category, like the Malaysian Lelong.

The two-part tariff has a few posers. “How should a firm assess entry and usage fees? Given the fact that the firm has some market power, should it go for a high entry fee coupled with low usage fees, or the other way around?” (Pindyk, Rubinfeld and Mehta 318). The solution needs a deeper understanding of the concepts involved:

Case I: One Consumer

A single consumer’s demand curve can be easily traced. If some other consumers have identical demand curves, they can be clubbed into this bracket. The firm has only one aim in mind: To extract as much consumer surplus as possible. In this case, the solution is simple. Pindyk, Rubinfeld and Mehta suggest that “Usage fee (U*) should be set at the Marginal Cost (MC; cost of one addition of a good) and the entry fee (E*) equal to the total consumer surplus for that customer / group of identical consumers. The customer pays U* as usage fee and multiples of U* per extra unit used” (318). A firm operating this way will absorb all consumer surplus.

Case II: Two Consumers

In this case, there are two different people or two sets of different people with identical demand curves. The limitation here is that the firm can fix only one E* and one U*. This implies that setting U* equal to MC will no longer be a viable related to the finances of the person/group of persons who have the lower
demand. If their requirements are overlooked and they are charged what the other group (the larger demand group) is paying, they will not buy the product or simply opt out. The net result will be the realisation of a less than optimum profit.

Pindyk, Rubinfeld and Mehta suggest that “The firm should set usage fee above marginal cost and then set the entry fee equal to the balance consumer surplus with the consumer having the smaller demand.” (318). There remains the question of valuation. To arrive at close to exact values of the two fees, the firm “will need to know the two demand curves, apart from its marginal cost. It can then write its profit as a function of U* and E* and select the two numerical values that maximise this function” (ibid).

Case III: Multiple Consumers

A large number of firms have to deal with a mixed bag of customers, with accompanying varied demands. Since the numbers of variables are too large to accommodate in a clear cut formula, an ideal two-part tariff cannot be served on a platter. A fair number of give and take experiments will become necessary.
Trade-offs will appear on the solution screen. Pindyk, Rubinfeld and Mehta explain: “A lower entry fee means more entrants and increased income” (319).

The risk lies in how low the entry fee is capped at. If E* is fixed below a certain value, the income no longer remains cost-effective. The problem is to derive an E*that provides the ideal number of entrants, translating into highest profit. “This can be done by setting a particular sales price, finding the optimum E* and estimating resultant profit” (ibid). The authors advise, “Change the sales price, calculate the corresponding E* and evaluate the new profit level. By iterating in this manner, the optimal two-part tariff can be arrived at” (319).

Awareness of MC and the summative demand curve is insufficient data to create any sort of understandable graphic representation. “Though it is not possible to determine the demand curve of every consumer, an idea of the variance in parameters would be of help” (ibid). “If their demand curves follow
some identifiable pattern, set the price close to MC and make E* large to capture the maximum possible consumer surplus,” advise Pindyk, Rubinfeld and Mehta (ibid). If no pattern is discernible, a less than optimum solution will have to be adopted, which is to “Set the price well above MC, charge a lower entry fee and accept the capture of a lower consumer surplus” (ibid).

Conclusion

In this paper, I have explained consumer surplus at length and shown that it is essentially a measure of potential profit. I have discussed pricing strategies in brief, including price discrimination, leading to the implementation of two-part tariffs. I have shown that the two-part tariff is not a cut and dried profit extraction policy, beset, as it is, by a host of variables. In each case, I have arrived at and explained the optimal method of extracting consumer surplus from the consumer, as well as its implementation by producers of a good or product. As long as there are market forces reaching out for consumer surplus, two-part tariffs are here to stay.



                                     Works Cited

Pindyk, Robert. S; Rubinfeld, Daniel. L and Mehta, Prem.L. Microeconomics Sixth Edition. Delhi: Dorling Kindersley(India), 2006. Print.
Sen, Anindya. Microeconomics Theory and Applications. Delhi: Oxford UP, 2006. Print

ONLINE MERCHANT SERVICES

If you're looking to accept credit cards online, you're going to need an Internet merchant account. There are plenty of banks and vendors offering you this service, but most of them don't offer everything you need. So, what are Internet Merchant Accounts?

Internet merchant accounts are merchant accounts specifically designed for processing credit cards online to provide online merchant services. Typically, the Internet version has more security controls than your traditional merchant account. In addition to an Internet merchant account, you'll also need a payment gateway service to move the money between your shopping cart and the banks or credit card companies involved with the transactions.

Small businesses also require some form of payment processing. Understanding how to select merchant services can impact your sales revenue and profit. Which type of company is best for a small business owner? It depends on your business situation. A home-based business owner may be turned down from a bank since their business is less established. Merchant service providers and independent sales organizations can be more flexible. While one person may feel comfortable dealing with their local bank, another might prefer a credit card processor who offers low rates. Choose a small business merchant account appropriate for your business.

If you allow a third party company to process your payments, you have to put your order form on the payment processing site. You may only be able to get your funds two or three times a month, limiting cash flow. With your own merchant account, expect to receive those funds in less than three days from the time of the transaction.

High Risk Merchant Account:  A high risk merchant account is generally needed for business owners whose creditors and bankers deem their business to be high risk, that is, there is lots of money involved and/or a very high potential for fraud. It used to be that high risk merchant accounts were solely associated with casinos, gambling and adult book/novelty stores.  These days, that conception couldn’t be further from the truth. Many types of businesses are considered to be high risk for one reason or another. There are, however, many solutions for business owners who are deemed to be high risk merchants as well as an increasing number of bankers and lenders who specialize in serving the needs of high risk merchants.  Many banks and credit/lending agencies specialize in creating high risk merchant accounts and coaching the business owner through the financial aspects of their business.  A high risk merchant account provider is the answer for a business owner who deals in a high risk business.

The first thing most people want to know is what type of business and under what circumstances does a business need a high risk merchant account.  Traditionally, high risk merchant accounts were associated with adult oriented stores and businesses as well any sort of business that dealt in gambling or gaming, like Keno bars or dog-racing tracks. This is because these businesses have a high credit that is there are lots of transactions, and they are often the targets of fraud and other schemes that make loaning money and processing payments on their behalf tricky.  With the advent of the Internet and e-commerce, as well as the growing need to protect investments and company value for shareholders, the list of businesses that require a high risk merchant account has gone up.  Some businesses that are generally considered to be high risk include most businesses that deal in e-commerce or sell items via Internet. This is because all Internet shopping, no matter what it is for, is at a higher risk of being the target of fraud.

Accepting Credit Cards Through Merchant Account Providers

    The Relation Between Accepting Credit Cards 

   and Merchant Account Providers

I am an online merchant selling surveys. I had set up a Bank to Bank payment link, which required that the customer had to provide his Bank details,  ISIN number, MICR number and other such details. I hardly managed to make enough money to keep my website going. I then added a Paypal account and business picked up, but I was losing money to Paypal every transaction. Moreover, there was the risk of a claim back, after the client had copied every detail I had sold him. Paypal would immediately refund the money, with me the loser both ways.  I then opted to collect payment directly by setting up a Credit Card payment facility to me and I would route the payment to my Bank. I finally started making money.

Running a successful business—especially an online business—means being able to process credit cards. However, finding the best solution for the process of accepting credit cards can be difficult. I examined different types of credit card processing solutions that offered a good list of resources for reference in my search for a credit card processing provider.

A merchant account is a type of bank account that allows businesses to accept payments by payment cards, typically debit or credit cards. A merchant account is established under an agreement between an acceptor and a merchant acquiring bank for the settlement of payment card transactions. In some cases a payment processor, independent sales organization (ISO), or merchant service provider (MSP) is also a party to the merchant agreement. Whether a merchant enters into a merchant agreement directly with an acquiring bank or through an aggregator such as PayPal, the agreement contractually binds the merchant to obey the operating regulations established by the card associations.

There are numerous merchant account providers for a business to choose from. The type of business that a company engages in plays a large part in what type of merchant account provider best suit its needs. The available options include:

Traditional banks

Independent sales organizations (ISO)

Offshore Merchant Account Providers

            Selecting the best merchant account providers calls for a lot of research and financial knowhow. Best merchant account services offer high approval ratings, speedy setup time and great customer service. The term "approval rating" for a merchant account service indicates how many applications the merchants account service approves. Choosing a Merchant Account Service is a business decision. The monthly costs of a merchant account should weigh heavily in this category. When you need to start taking payment via credit and debit card, you need to do it fast. Account setup time and cost should be minimal-some offer zero set up cost. The service must offer excellent customer service twenty-four hours a day, all online.

Shared Mailboxes and Shared Email

What is a Shared Mailbox?

A shared mailbox is an email address that more than one person has the right to access. People are given appropriate access to the common mailbox as and when required. These mailboxes are standard email folders and are no different to your own email folders, except that a number of people can be given access to the shared item or unit. In other words, such mailboxes allow a group of users to view and send e-mail from a common mailbox. They also allow users to share a common calendar, so they can schedule and view vacation time or work shifts.

It can apply to a personal email address, a purpose built address to share email  and a sub mail folder and can be used to:

•     Organise and control your mail, quantity of mails and archiving.

•     Provide clearly defined email addresses for business use.

•     Emails to a contact address (e.g. dental-enquiries@flint.net) will now be sent  to a single shared mailbox. This arrangement allows easier administration for all;  e.g. whether or not the query has been answered.

•     A single copy of the email is stored, as opposed to multiple copies when email lists are used.

•     The shared box is considered separate, freeing up your personal quota.

•     A clear distinction between business email and personal email makes it easier to facilitate access to email when people are on leave or move between jobs or roles.

•     It is more convenient for archiving, and allows members who have recently joined the list to catch up with previous emails and present members to review the use.

Shared Inbox for Gmail

The Gmail share inbox is an app that allows users of Google Apps email to share email addresses among multiple users. More than just sharing the address with multiple users, the Shared Inbox lets group members assign tasks to other members of the group. Responses sent to customers come from the Shared Inbox address instead of from the individual team member. This facility is available to any company using Google Apps email on their company domain. Sold on the Google Apps marketplace, a standard Shared Inbox account costs only $10/user/year