For a two-part tariff imposed in a market made up of identical consumers, the fixed fee should be set equal to:

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Question restatement: The problem asks, for a two-part tariff in a market with identical consumers, to determine the appropriate level for the fixed fee. The given answer indicates the fixed fee should be set equal to: b) consumer surplus.

First, consider what a two-part tariff consists of: a per-unit price (often set at marginal cost to avoid welfare loss) and a fixed access fee charged to each user. The fixed fee is designed to extract some or all of the consumer surplus without reducing participation.

Option discussions, assuming standard options one might encounter:
- If the fixed fee were set to total profit or total willingness to pay, that would generally misalign with the objective of extracting surplus while keeping consumers willing to participate. Such a level could overcharge and deter entry.
- If the fixed fee matched average cost or another cost measure, it would fail to capture the consumer surplus that arises from the units consumed, leaving some welfare left with consumers or distorting participation depending on the structure.
- If the fee were set at marginal cost, it would typically extract no fixed fee and leave all surplus to consumers; this would underutilize the tariff’s potential to extract surplus.
- If the fixed fee were tied to some external metric (e.g., fixed overhead unrelated to willingness to pay), it could misalign incentives and either overextract or underextract surplus, reducing participation or welfare efficiency.

Why the fixed fee should equal consumer surplus:
- In a market with identical consumers and a per-unit price set at marginal cost, each consumer’s consumer surplus from the quantity consumed is the maximum amount they would be willing to pay above the marginal cost for that quantity.
- A fixed fee equal to this consumer surplus captures exactly the surplus that each consumer would enjoy from participating, leaving them with zero net surplus after paying both the per-unit charges and the fixed fee.
- This setup induces all consumers to participate (since the fixed fee is precisely the amount of surplus they would derive) while preventing the monopoly from extracting more than the entire surplus, which would distort welfare.
- In collective terms, setting the fixed fee equal to consumer surplus implements an efficient extraction: it neutralizes the incentive to selectively attract some consumers over others since all identical consumers face the same CS and thus the same fixed fee. Wasteful deadweight loss is avoided, and participation is preserved.

Potential misconceptions addressed:
- Thinking the fixed fee should be set to average or total costs ignores the distribution of willingness to pay among consumers and fails to extract surplus without reducing participation.
- Assuming any fixed fee above consumer surplus would price some consumers out; below it would underextract surplus, leaving unrealized monopoly gains and potentially inducing inefficiencies.
- Believing the fixed fee should be tied to unrelated metrics misaligns incentives and can distort consumption or hurt welfare.

In summary, with identical consumers and a per-unit price at marginal cost, charging a fixed fee equal to the individual consumer surplus captures all the surplus from participation without excluding anyone, which is why the fixed fee is set equal to consumer surplus.

ECON 4001.01 SP2025 (19496) Week 11 quiz

For a two-part tariff imposed in a market made up of identical consumers, the fixed fee should be set equal to:

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