Nonlinear Pricing with Misspecified and Arbitrary Perception of the Marginal Price

TL;DR

This paper analyzes how consumer biases in perceiving marginal prices affect optimal nonlinear pricing strategies and welfare, finding that misspecification often benefits monopolists without harming overall welfare under certain conditions.

Contribution

It provides a theoretical analysis of optimal quadratic pricing under consumer perception biases, showing limited welfare impact and potential benefits for monopolists.

Findings

Bias in marginal price perception has negligible effect on maximum welfare.

Misspecification often benefits the monopolist.

Bias negatively impacts aggregate consumption reduction strategies.

Abstract

In the context of nonlinear prices, the empirical evidence suggests that the consumers have cognitive biases represented in a limited understanding of nonlinear price structures, and they respond to some alternative perceptions of the marginal prices. In particular, consumers usually make choices based more on the average than the marginal prices, which can result in a suboptimal behavior. Taking the misspecification in the marginal price as exogenous, this document analyzes how is the optimal quadratic price scheme for a monopolist and the optimal quadratic price scheme that maximizes welfare when there is a continuum of representative consumers with an arbitrary perception of the marginal price. Under simple preferences and costs functional forms and very straightforward hypotheses, the results suggest that the bias in the marginal price doesn't affect the maximum welfare attainable with quadratic price schemes, and it has a negligible effect over the efficiency cost caused by the monopolist, so the misspecification in the marginal price is not relevant for welfare increasing policies. However, almost always the misspecification in the marginal price is beneficial for the monopolist. An interesting result is that under these functional forms, more misspecification in the marginal price is beneficial for both the consumers and the monopolist if the level of bias is low, so not always is socially optima to have educated consumers about the real marginal price. Finally, the document shows that the bias in the marginal price has a negative effect on reduction of aggregate consumption using two-tier increasing tariffs, which are commonly used for reduction of aggregate consumption.