Two part tariffs with partial product bundling

Abstract

When a firm operates in an industry with very large differences in consumers' willingness to pay for the service it offers, it faces a challenge in the pricing decision. It wants to engage in price discrimination, but cannot identify a given consumer's market segment ex ante. When consumers' willingness to pay is private information, a widely used sorting mechanism is to offer a menu of two part tariffs, letting high demand and low demand consumers self-select into distinct market segments by their tariff choice. However, when the difference in consumers' willingness to pay is very large, simple two part tariffs are not longer sufficient to discriminate between high and low demand segments; Despite the ability to price discriminate, the firm still prefers to serve high demand consumers only. The model suggests that it might be possible to discriminate between consumers by other means than price-cost distortions; Low demand consumers face a two part tariff with a per unit price possibly above marginal cost, together with a restriction on usage, whereas high demand consumers face an efficient two part tariff.