Risk-Averse Firm and Two-Part Tariffs

Abstract

Under demand uncertainty, a risk-averse firm adopts marginal-cost pricing when consumers are homogenous. When consumers are heterogeneous, the equilibrium price tends to move towards marginal cost as the firm’s risk aversion increases and it equates marginal cost if the firm is infinitely risk averse. Two-part pricing yields a lower risk cost than linear pricing or even completely eliminates the risk. Under cost uncertainty the firm charges a risk premium and the equilibrium price monotonically rises as the firm’s risk aversion increases. However, the risk premium is likely to reflect the risk cost the firm bears rather than rent seeking.