Nonlinear Pricing: Evidence of Price Discrimination in the Fluid Milk Market

Abstract

Firms may use nonlinear price schedules, possibly to the detriment of some consumers, to price discriminate and increase profits. However, it is possible that these nonlinear price schedules may also increase welfare from the consumer's perspective if they are able to serve portions of a market that firms may otherwise ignore. The more extensive theoretical literature on price discrimination shows how firms may use nonlinear price schedules to price discriminate by distorting product characteristics from their efficient levels given heterogeneous preferences among consumers. Additionally, the theoretical literature finds that whether or not this practice is welfare decreasing or increasing from the consumer's perspective depends on a number of factors, thus implying that the welfare implications of price discrimination from the consumer's perspective is an empirical question. Subsequently, some recent empirical papers have found this form of second-degree price discrimination to be welfare decreasing from the consumer's perspective whereas other papers, depending on the analyzed market, have found it to be welfare increasing. In this paper, I study the consumer welfare implications of nonlinear pricing in the market of fluid milk. Variation in the ratio between marginal price per ounce and marginal cost per ounce over the menu of options is evidence that firms are using nonlinear pricing schedules to price discriminate. Once this evidence is shown, I use counterfactual analysis to determine the welfare implications of this practice within the market for fluid milk from the consumer's perspective. I find that firms within this industry are using nonlinear pricing to price discriminate for private label products, of which conservative estimates show that approximately 7.20% of the markup differential between sizes can be explained by price discrimination. However, I find that very little of the markup on Regional branded products, approximately 0.32%, can be attributed to price discrimination. In my most compelling set of counterfactual analyses, I show that consumers are worse off due to price discrimination and my counterfactual analysis shows that households are on average anywhere between $0.0249 to $.0555 to worse off per shopping trip under a forced linear pricing, which corresponds to a total yearly welfare difference between $63 million to $140 million per year within my sample region due to the nonlinear pricing strategies used by firms in the marketplace. Additionally, I estimate and utilize models similar to the status quo in the literature on price discrimination thus far that do not have household demographic characteristics included and compare them my preferred specification which does, showing that ignoring the demographic makeup of the marketplace's individuals and actual consumer decisions leads to potentially biased parameter estimates.