I spent these two classes going over two-part tariffs. Were this just the algebra, it would be overkill. The novelty, if any, was to tie the whole business to how one should price  in a razor & blade business (engines and spare parts, kindle and ebooks etc). The basic 2-part model sets a high fixed fee (which one can associate with the durable) and sells each unit of the consumable at marginal cost. The analysis offers an opportunity to remind them of the problem of regulating the monopolist charging a uniform price.

The conclusion of the basic 2-part model  suggests charging a high price for razors and a low price for blades. This seems to run counter to the prevailing wisdom. Its an opportunity to solicit reasons for why the conclusion of the model might be wrong headed. We ran through a litany of possibilities: heterogenous preferences (opportunity to do a heavy vs light user calculation), hold up (one student observed that we can trust Amazon to keep the price of ebooks low otherwise we would switch to pirated versions!), liquidity constraints, competition. Tied this to Gillete’s history expounded in a paper by Randall Pick (see an earlier post ) and then onto Amazon’s pricing of the kindle and ebooks (see this post). This allowed for a discussion of the wholesale model vs agency model of pricing which the students had been asked to work out in the homework’s (nice application of basic monopoly pricing exercises!).

The `take-away’ I tried to emphasize was how models help us formulate questions (rather than simply provide prescriptions), which in turn gives us greater insight into what might be going on.