On the Inefficiency of Two-Part Tariffs

Abstract

The partial equilibrium literature on two-part tariffs suggests that if a commodity is produced under increasing returns, efficiency can be achieved through marginal cost pricing and a suitable choice of “entry fees” (fixed charge) which may vary from consumer to consumer. We show that this partial equilibrium intuition cannot be extended beyond some special cases. Even with a consumer-specific fixed charge, it is possible that none of the equilibria yield Pareto efficiency. Furthermore, it may be impossible to achieve Pareto efficiency through any specification of taxes which are levied solely to cover losses.