1. University of Louisville, U.S.A.
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    • This article is based on Chapter II of my Ph.D. dissertation. I am very grateful to my advisor, Guofu Tan, for his continuing support, encouragement, and suggestions on this article. I would like to especially thank the editor and two anonymous referees for their comments and suggestions that greatly improved the article. I would also thank Mark Armstrong, Isabelle Brocas, Juan Carrillo, Harrison Cheng, Timothy Derdenger, Anthony Dukes, Nicholas Economides, Per Fredriksson, Stephen Gohman, Michael Grubb, Shmuel Leshem, Domenico Menicucci, David Sibley, Simon Wilkie, Ralph Winter, and seminar participants at the University of Southern California, Australian National University, University of Louisville, Shanghai University of Finance and Economics, 2010 KEA Annual Conference, 80th SEA Annual Meeting, 2011 MEA Annual Meeting, 9th Annual IIOC, 2011 CES Conference, and 38th Annual EARIE Conference. I gratefully acknowledge the financial support from the USC Summer Dissertation Fellowship, the Microsoft Corporation Research Grant, the NET Institute Grant, and the USC Graduate Merit Award Fellowship. The usual caveat applies. Please address correspondence to: Yong Chao, Department of Economics, College of Business, University of Louisville, Room 185, Louisville, KY 40222. Phone: 502-852-3573. Fax: 502-852-7672. E-mail:


The distinct element of a three-part tariff (3PT), compared with linear pricing (LP) or a two-part tariff, is its quantity target within which the marginal price is zero. This quantity target instrument enriches the firm's strategy set in dictating the competition to a specific level, even in the absence of a usual price discrimination motive. With general differentiated linear demands, the competitive effect of a 3PT in contrast to LP depends on the degree of substitutability between products: Competition is intensified when two products are more differentiated, yet softened when two products are more substitutable.