In Sweden, district heating of buildings is in common use. This paper deals with the district heating tariff. Many economists argue that the tariff should be based on short-range marginal costs, but in practice this never occurs. Traditionally instead, the prices are set so they are lower than the alternatives. A case study is presented dealing with a residential building in Navestad, Norrkoping. For this building, the life-cycle cost with extra wall insulation and the introduction of a heat pump has been calculated. A comparison of two perspectives, the present tariff and a tariff-based short-range marginal cost, is done. It is shown that there is a conflict between the two perspectives. For the tariff based on short-range marginal cost, neither extra insulation nor an introduction of a heat pump is profitable. However, with the present tariff, a bivalent system with a heat pump and district heating is profitable. Copyright (C) 2002 John Wiley Sons, Ltd.