Under certain conditions, a firm with market power can increase its profit by charging different amounts for different units of the same good.
To do so, the firm must be able to distinguish purchases that involve a high willingness to pay from purchases that involve a low willingness to pay.
A firm engages in quantity-dependent (or volume-sensitive) pricing when the price a consumer pays for an additional unit depends on how many units the consumer has bought.
Perfect price discrimination
When a monopolist knows the customer's willingness to pay for every unit he sells and can charge a different price for each unit, he can perfectly price discriminate. Perfect price discrimination maximizes aggregate surplus (there is no deadweight loss), but consumers receive no surplus at all.
A monopolist who can perfectly discriminate can also maximize his profit using a two-part tariff in which the per-unit price equals the marginal cost and each consumer pays a fixed fee that reduces consumer surplus to zero.
Price discrimination based on observable customer characteristics
Sometimes a firm that can't perfectly price discriminate can nonetheless distinguish between two or more distinct groups of customers.
In that case, the firm can set a different price for each group, using the methods described in Section 17.2. When the firm does so, it sets a higher price for groups whose demand is less elastic than for groups whose demand is more elastic.
Compared to simple monopoly pricing (see Section 17.2), price discrimination based on observed customer characteristics may either raise or lower consumer surplus and aggregate surplus.
Price discrimination can't occur in a perfectly competitive market, but it can exist in markets that are nearly perfectly competitive. It can also be greater in oligopoly markets than in monopoly markets.
Price discrimination based on self-selection
Sometimes a monopolist knows that different customers belong to different groups, but can't distinguish among them. In such cases, it may be able to price discriminate by offering each customer a menu of alternatives, designed so that different customers will make different choices. One tool that firms often use to price discriminate based on self-selection is quantity-dependent pricing.
When a monopolist offers a single two-part tariff to more than one group of consumers, it can extract more of the high-demand consumers' surplus by raising the per-unit price above the marginal cost. The degree to which it is worthwhile doing this depends on the relative proportions of the different types of consumers.
The monopolist can further increase its profit by offering a menu of two-part tariffs, each one targeted at a different group of consumers. In designing the menu, the monopolist should try to make each plan attractive to the group it is intended for but unattractive to the other groups. Doing so involves capping the quantity that can be purchased in the low-demand plan at the level that low-demand consumers desire to buy given the per-minute price in that plan. It should also offer high-demand consumers a plan with a per-unit price equal to its marginal cost to eliminate their deadweight loss.
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Bundling
For a firm that sells more than one product, it is sometimes profitable to make the price or availability of one good dependent on the customer's purchase of another good. One version of this tactic is the practice of selling goods together as a bundle.
Bundling always increases a multiproduct monopolist's profit whenever an increase of a dollar in the willingness to pay for one good implies a reduction of a dollar in the willingness to pay for another good and the marginal cost is zero. In that case, there is no variation in consumers' willingness to pay for the bundle, and the monopolist can extract all of aggregate surplus as profit by bundling. However, bundling can also increase the monopolist's profit in other circumstances.
A firm can sometimes profit by engaging in mixed bundling, where it sells a bundle but also sells the products in the bundle individually.
