Question

When cell phones were first introduced, bandwidth was limited, which led to economically interesting pricing structures. One by Spring offered 4,000 free minutes for $39.99 a month. The fine print revealed a catch. Only 350 of those minutes were anytime minutes; the remaining were restricted to evening and weekend usage. If you went over your allotted time, you were charged 35 cents per minute for any additional minutes.

a. What was your marginal cost? Graph it.

b.What would your average variable cost curve for peak time usage have looked like?

c.If you did not keep track of your usage, how would you figure your marginal cost?

d.Why did firms offer such confusing plans?

e.Were firms that charged this way in favor of or against portability of phone numbers?

f.Why are these offers no longer prevalent?

Answer 1

A) The $39.99 fee per month for the plan is a fixed cost. After the user has exhausted 350 anytime free minutes, he/she gets restricted to talk only in non-peak hours or days. These 3,650 minutes are also included in the plan. However, if the user goes over allotted time, it will cost him/her 35 cents per minutes for peak hours. As per definition, marginal cost refers to the additional cost incurred for an additional unit. So, any minutes after the allotted time will be chargeable at 35 cents per minute which implies that the additional cost incurred for each additional minute used in peak hours is 35 cents per minute. Therefore, it will the marginal cost for each minute used over the allotted time.  

We have calculated the marginal cost in cents for the number of minutes and it has been shown in the table given below. When we plot a graph out of it, we get a straight upward sloping line as the marginal cost increases with each minute.  

The graph below shows the marginal cost in cents of a user for every minute used after the allotted time.  

B) At peak time, the minutes used will be chargeable for 35 cents per minute. This implies that if we use 1000 minutes in peak time, we get charged 35000 cents (35*1000). The average variable cost can be calculated by using the following formula:

Average variable cost = Total variable cost / Number of minutes

Since MC is increasing, the average cost curve will be U-shaped. This is so because when MC is increasing, average variable cost decreases at first and then after it becomes equal to MC, it starts increasing.  

C) If we did not keep track of out usage, we can still calculate our marginal cost by using the following formula:

Marginal cost of using nth minute = Total variable cost of using nth minute - Total variable cost of using (n-1)th minute

We can check our bill for the minutes used and then calculate the marginal cost by using the formula specified above.  

D) Firms offer such confusing plans so that the prices seem cheap and more people enroll themselves and buy the plan. They use psychology by advertising low prices and trick our mind into believing that the plans are cheap and we should buy them, when in reality consumers hardly focus on the fine print. They take advantage of this and keep the prices hidden.  

E) The firms were not in favor of portability as there were not many options available at that time and all the companies charged high prices. So, they were not concerned about portability. Also, they used to sell cell phones along with the sim which gave people less choice.  

F) These offers are no longer prevalent because once people realize they are being charged more, they switch to other firms and this affects consumer satisfaction. The consumers become unhappy and the firms make loss in the long-run. Thus, they prefer honest pricing now.