Risk-Averse Firms and Two-Part Tariffs under Uncertainty

Abstract

This paper studies two-part tariffs with explicit consideration of cost uncertainty and risk aversion. It finds that firms charge a risk premium over expected marginal cost for each unit they sell. This pricing rule is socially optimal if and only if the modeled market is fully covered in equilibrium. A risk-averse monopoly tends to generate less aggregate net consumer surplus than a risk-neutral monopoly in partial-cover equilibrium but consumer welfare is indifferent when the market is fully covered. In oligopoly, consumer welfare increases (decreases) in the Arrow-Pratt measure of absolute risk aversion when the number of firms is relatively large (small).