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

46 Pages Posted: 1 Apr 2021 Last revised: 25 Sep 2022

See all articles by Roberto Corrao

Roberto Corrao

Massachusetts Institute of Technology (MIT), Department of Economics, Students

Joel P. Flynn

Massachusetts Institute of Technology (MIT) - Department of Economics

Karthik Sastry

Harvard University, Department of Economics

Date Written: September 23, 2022

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

Suggested Citation

Corrao, Roberto and Flynn, Joel P. and Sastry, Karthik, Nonlinear Pricing with Under-Utilization: A Theory of Multi-Part Tariffs (September 23, 2022). Available at SSRN: https://ssrn.com/abstract=3817175 or http://dx.doi.org/10.2139/ssrn.3817175

Roberto Corrao

Massachusetts Institute of Technology (MIT), Department of Economics, Students ( email )

Cambridge, MA
United States

Joel P. Flynn (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
E52-391
Cambridge, MA 02142
United States

Karthik Sastry

Harvard University, Department of Economics ( email )

Cambridge, MA 02138

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