Nonlinear Pricing with Random Participation

Review of Economic Studies, January 2002, 69(1)

Posted: 16 Feb 2014

See all articles by Lars Stole

Lars Stole

University of Chicago - Booth School of Business

Jean-Charles Rochet

GFRI, University of Geneva; Swiss Finance Institute; University of Zurich - Swiss Banking Institute (ISB)

Date Written: February 1, 2001

Abstract

The canonical selection contracting programme takes the agent's participation decision as deterministic and finds the optimal contract, typically satisfying this constraint for the worst type. Upon weakening this assumption of known reservation values by introducing independent randomness into the agents' outside options, we find that some of the received wisdom from mechanism design and nonlinear pricing is not robust and the richer model which allows for stochastic participation affords a more general empirical specification. We develop a multidimensional methodology for addressing this class of problems, providing two important applications to nonlinear pricing. First, with nonlinear pricing by a monopolist the familiar "no-distortion-at-the-top" result persists, but in tandem with the surprising conclusion that there is either no distortion at the bottom or bunching. Second, in a simple model of product differentiated duopolists competing with nonlinear pricing we show that, generally, the duopoly outcome is qualitatively similar to the monopoly outcome. However, when marginal costs are symmetric and competition is sufficiently intense, distortions disappear and the equilibrium outcome takes a remarkably simple form: efficient quality allocations with cost-plus-fee pricing.

Keywords: Contract theory, Incentives

JEL Classification: C70, D82

Suggested Citation

Stole, Lars A. and Rochet, Jean-Charles, Nonlinear Pricing with Random Participation (February 1, 2001). Review of Economic Studies, January 2002, 69(1). Available at SSRN: https://ssrn.com/abstract=2396162

Lars A. Stole (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7309 (Phone)
773-702-0458 (Fax)

Jean-Charles Rochet

GFRI, University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
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University of Zurich - Swiss Banking Institute (ISB) ( email )

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CH-8032 Zurich, Zurich 8032
Switzerland

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