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500 CHAPTER 12 CAPTURING SURPLUS

purchase Q 1L units. But suppose the company intro- tion of electricity from Q 1L to Q 2L units, increasing his
duces a block tariff, charging P 1 per unit for the first consumer surplus by area I. And the company will be
Q 1L units purchased and a lower price P 2 per unit for better off because its producer surplus will increase
any additional units. How will the block pricing affect by area II.
Mr. Small, Mr. Large, and the electric power company? This example illustrates an important potential
Mr. Small’s purchases are unchanged because he benefit of block tariffs. If we start with a uniform
does not purchase enough electricity to take advan- price that is different from marginal cost, then intro-
ducing a block tariff leads to a Pareto superior allocation
tage of the lower block price P 2 . He still buys Q 1S
units at a price P 1 , and his consumer surplus is there- of resources. A Pareto superior allocation of resources
fore the same as it was under the uniform pricing makes at least one participant in the market better
system. Mr. Large, however, will expand his consump- off and no one else worse off. 9

Pareto superior An that this is a system of quantity discounting by considering the consumer’s average
allocation of resources that cost per call. If the consumer makes two calls per month, the bill will be $20 $0.10
makes at least one partici- $20.10, and the average outlay per call will be $10.05. In contrast, if the consumer
pant in the market better makes 200 calls per month, the bill will be $20 $10 $30, but the average outlay
off and no one worse off.
per call will be only $0.15.
How might a firm use subscription and usage charges to capture more surplus?
Let’s consider a simple example in which all consumers are alike, each having a de-
mand for telephone service like the one shown in Figure 12.8. Assume the telephone
company incurs a marginal cost of $0.05 for each call. The company could make sure

Price ($ per call) S 1

FIGURE 12.8 Subscriber and Usage Charges
Each consumer has the demand curve D for tele- $0.05 MC
phone service, and the telephone company incurs
a marginal cost of $0.05 for each call. If the com-
pany sets a usage charge of $0.05 for each call, D
the consumer would make Q 1 calls each month
and realize a consumer surplus of S 1 . The telephone
company could capture virtually all the consumer Q 1
surplus by implementing a monthly subscription Quantity (calls per month)
charge of slightly less than S 1 dollars.

9 For more on this topic, see R. D. Willig, “Pareto Superior Nonlinear Outlay Schedules,” Bell Journal
of Economics 9 (1978): 56–69. With respect to the market for electricity, the argument for the Pareto
superiority of nonlinear outlay schedules is clearest when the consumers are end users of electricity
(e.g., households). The argument is a bit more complex when the purchasers of electricity are firms that
compete with one another in some market. One of the complications arises because quantity discounts
from block pricing could conceivably allow a larger, less efficient firm to produce with lower costs than a
smaller, more efficient firm, because the larger firm can purchase electricity at a lower average price.
Pareto superiority is named for the Italian economist Vilfredo Pareto (1848–1923).