Two-Part Tariffs with Quality Degradation

Abstract

There is a gap between the recommendations of the theory of second degree price discrimination and the practices of firms that target consumer segments with varying willingness to pay with two or more distinct tariffs. We present a model where consumers' private information is single dimensional and the allocation rule is two-dimensional. In contrast to the established result in nonlinear pricing, we find that the per-unit price may be non-monotonic: low-demand consumers face a two-part tariff with a per-unit price possibly below marginal cost, and even zero, whereas high demand consumers face tariffs with per-unit charges above marginal cost. On the other hand, all consumers but the one on the top of the distribution are faced with a quality restriction, quality being monotonically increasing in type. Finally, we show that this practice increases welfare due to increased consumption efficiency.