The Study On The Social Welfare Effect Of Nonlinear Pricing

Microeconomic theory states that without externality, monopoly and commodity tax, Marginal Cost Pricing (MCP) is the only pricing way to achieve best resource allocation and social welfare maximum. For a long time, MCP had been proved to be the first-best in theory; however, problems appeared when natural monopoly enterprises took MCP into use. And the most famous problem was "cost compensation" of the natural monopoly company. Because of the "increasing returns to scale", the average cost of the production will decrease when the scale increases, so the marginal cost will always lower than average cost of the production, the MCP cannot help the company to compensate it’s cost, and this will result in loss.Economists have made efforts to resolve the "cost compensation" problem of the natural monopoly company in these two different ways:1.Maintian the MCP unchanged, compensate the deficit company by mechanism designing.2. Give up the MCP, turn to a second-best pricing strategy to balance "social welfare loss" and "cost compensation of the natural monopoly", like Ramsey Pricing. There is one thing in common when summarizing the pricing strategies mentioned above. Once the company determines its price, it will not change for any type of consumer. We call this pricing strategy "Linear Pricing". Consider the real effect of these "Linear Pricing" strategies, we find out that they don’t work effectively on the natural monopoly pricing problem, they are all making balance among factors like economic efficiency, cost compensation, and social equity.Since all the solutions of the "cost compensation" problem are at the spend of welfare loss, the scholars began to consider how can we minimize this loss? Some of them pointed out that if the heterogeneous consumer can be divided and the "Nonlinear Pricing" can be practiced, the "cost compensation" problem would be resolved easily, further more, the welfare loss of "Nonlinear Pricing" is exactly smaller than the Linear one.Unfortunately, at present, all studies of the social welfare result of "Nonlinear Pricing" are based on two specific market structures:complete monopoly market and symmetry duopoly competitive market. Although they provide a basic analytical framework and their conclusions are significant, they still cannot describe the reality precisely because their market structure hypothesis is far from reality. In the real world, the nature monopoly companies are always in an "asymmetric duopoly market", like China Mobile and China Unicom, one of them is stronger. But few studies of "Nonlinear Pricing" takes this market structure into consider, and none of them drew conclusions about social welfare effect.If we can make some conclusions about the welfare result of "Nonlinear Pricing" from this asymmetric duopoly market structure, it will be useful to the price regulation and the pricing practice of the natural monopoly company.The third chapter of this paper gives the analytical framework about "asymmetric duopoly market". In this chapter, we describe the "asymmetric duopoly companies","homogeneous products","heterogeneous consumers" and "different pricing strategies of companies" in detail, further more, we give "eight basic hypothesis" and "welfare measurement method" to establish the mathematic model.Based on "asymmetric duopoly market" structure, the fourth chapter assumes that the companies will choose "Linear Pricing", while the fifth part assumes the "Nonlinear Pricing" will be practiced. Then we calculate the welfare result of these two situations respectively.When "Linear pricing" is practiced, the "stronger company" will be at the dominant position in the market, and it will have strong incentive to occupy the whole market. Without the "asymmetric regulatory policy", the "weaker company" cannot survive. The "stronger company" has the power to decide the price, while the "weaker company" can only decide its own output according to the given price. Because the products are totally the same, the equilibrium price of both companies should be equal; otherwise, the company with lower price will occupy the whole market. The equilibrium price will be equal to the marginal cost of the "weaker" company, because at this price level, neither two companies want to change its price anymore. The high-type consumers can always remain in the market, but the low-type consumers need some conditions to stay, because when the price is higher than a certain value, the demand of the low-type consumers will decrease to zero or into negative value, and they will quit the market. Therefore, the aggregate demand curve will be a kinked curve.When "Two-part tariff’which is the most general type of "Nonlinear pricing" is practiced, the two companies have different price level. The "stronger company" will set its price by "high fixed fee" and "low marginal price", while the "weaker company" choose the combination of "low fixed fee" and "high marginal price". In this situation, the consumer group will also be divided. The high-type consumers will prefer the products from "stronger company" while the low-type consumers prefer products from "weaker company". Although both companies can occupy one part of the market, the existing of competition pressure will make their price level much lower than the monopoly price. The boundary of high-type consumers and low-type consumers is not fixed, no matter which company raise its price level, its market share will reduce, vice versa. For this reason, both companies will try to lower its price level to enlarge its market share, but lower price will decrease the profit of unit product, so they should find a balance to maximize their gross profit.The fifth part tells more about one welfare drawback of "Nonlinear Pricing" which is called "Consumption Trap". We point out that although we can’t observe the "Consumption Trap" described in theory, it indeed exists, the existence of consumption trap depends on some specific decision-making paths of the consumers.After we have got the welfare results of "Linear Pricing" and "Nonlinear Pricing", the sixth chapter makes a comparative study of them. We concluded that if we change the pricing strategy form "Linear" to "Nonlinear", the welfare of producers will be improved. This welfare improvement will be affected by two factors:"consumer heterogeneity" and "marginal cost difference between companies". When cost differences increases, the welfare advantages will be more remarkable; when consumers are more heterogeneous, the welfare advantages will be more prominent. But not every company can always benefit from "Nonlinear Pricing", the "stronger company" will suffer welfare loss by "Nonlinear Pricing" when the marginal cost difference of two companies is huge.If we change the pricing strategy form "Linear" to "Nonlinear", the welfare of consumers will also be improved, and this welfare improvement will be affected by "consumer heterogeneity". When consumers are more heterogeneous, the welfare advantages will be more remarkable. However, not every consumer can get a welfare increment through this change. The "Nonlinear Pricing" can benefit high-type consumers at any time, but when the marginal cost difference of two companies is very small, the low-type consumers will indeed suffer a welfare loss. This means other market entities can deprive welfare from low-type consumers when the marginal cost difference of two companies is very smallBased on analysis of part six, we point out that even though there will be welfare exploit and transfer between different market entities when "Nonlinear Pricing" is practiced, but if we take the producers, or the consumers, or even the whole society as a group, their welfare can always be improved by this pricing change. After we give up the Marginal Cost Pricing for natural monopoly enterprises, there are already some welfare loss there, the welfare improvement brought by "Nonlinear Pricing" is indeed a compensation for this loss. And this is exactly the welfare advantage of "Nonlinear Pricing" strategy we want to improve in this paper.At the end, we summarize the conclusions of this paper, and give some suggestions about "pricing of enterprises","regulation of nonlinear pricing","cultivate the competitive market entities and competitive mechanism","universal service responsibility", and "social equity" according to our research.