After graduation, you start an internet-based firm that allows people to buy and sell books online. Based on your market research, you believe there are two basic types of customers

Question

The first type is the casual reader who has relatively low willingness-to-pay for your services, and their annual demand is Q1 = 30 - 40P where Q1 is the number of books traded per year and P is the price you charge per book traded. The second type of customer is the avid reader who has relatively high willingness-to-pay for your services, and their demand is Q2 = 100 - 50P. The marginal cost of your online service is $0.40 per book traded. a. If you set your usage fee equal to the marginal cost, how many books will each type of customer trade on your system? What is the consumer surplus enjoyed by each type of customer? b. What is the optimal entry fee that you should charge under a two-part tariff pricing scheme for access to your online market? How much consumer surplus is left for the two types of customers after they pay the entry fee and usage fee?

Answer 1

a.
For the first group (casual readers), the quantity of book trading services demanded is Q1 = 30 - 40(0.40 ) = 14 books per year. The price-dependent demand curve for these customers is P = 0.75 — 0.025Q1, and the consumer surplus based on marginal cost pricing is CS1 = 14(0.75 - 0.40 )/2 = $2.45 per year. For the second group (avid readers), the quantity of book trading services demanded is Q2 = 100 - 50(0.40 ) = 80 books per year. The price-dependent demand curve for these customers is P = 2 - 0.02Q2, and the consumer surplus based on marginal cost pricing is CS2 = 80(2 - 0.40)/2 = $64.00 per year.

b.
The optimal entry fee equals the consumer surplus for the casual readers, which is $2.45 based on the results from part a. After this entry fee is imposed, the casual readers have zero consumer surplus remaining, and the avid readers have $61.55 consumer surplus remaining.