Prior Cost-reducing Investment and Pricing Schemes: Linear Pricing or Two-part Tariff?

Abstract

This paper analyzes two pricing schemes (linear pricing and two-part tariff) offered by a producer in which it sells a product a separate retailer who makes a cost-reducing investment before contract. Linear pricing has the advantage of providing the investment incentive for the retailer, but has the disadvantage of double marginalization. On the other hand, two-part tariff has the advantage of dissolving double marginalization, but has disadvantage of withdrawing investment incentive to the retailer. The initial marginal cost and the efficiency on investment play important roles in equilibrium. If the initial marginal cost is high and the efficiency on investment is high, the producer offers a linear pricing to its retailer.