Nonlinear Pricing with Under-Utilization: A Theory of Multi-Part Tariffs

Abstract

We study the nonlinear pricing of goods whose usage generates revenue for the seller and of which buyers can freely dispose. The optimal price schedule is a multi-part tariff, featuring tiers within which buyers pay a marginal price of zero. We apply our model to digital goods, for which advertising, data generation, and network effects make usage valuable, but monitoring legitimate usage is infeasible. Our results rationalize common pricing schemes including free products, free trials, and unlimited subscriptions. The possibility of free disposal harms producer and consumer welfare and makes both less sensitive to changes in usage-based revenue and demand.

Keywords: Screening, Adverse Selection, Moral Hazard, Multi-Part Tariffs, Under-Utilization, Free Disposal, Digital Goods

JEL Classification: D82, D42, L11