Two-part tariffs with quality degradation

Abstract

This paper examines a firm's incentive to sell a service that is of lower quality when the firm offers a menu of two-part tariffs. Each tariff is characterized by a fixed fee together with two screening instruments, these being a uniform per unit charge and a quality restriction. We find that allocation of quality is monotonic in type, while per unit charge might be non-monotonic. The results thus contradict one of the most established insights in nonlinear pricing, that the per unit charge should be monotonically decreasing over the type space. We show that this practice increases welfare due to increased consumption efficiency.