When Does an Optional Tariff Not Lead to a Pareto Improvement? The Ambiguous Effects of Self-Selecting Nonlinear Pricing When Demand Is Interdependent or Firms Do Not Maximize Profit

AbstractJohn C. Panzar & J. Gregory Sidak

Optional or self-selecting tariffs allow customers to choose between an established tariff and an alternative outlay schedule. The possibility of making the vendor and at least one consumer better off, without making any other consumer worse off, makes optional tariffs appealing to both economists and regulators. In economic terms, the introduction of optional tariffs makes possible a Pareto improvement in the allocation of resources. Unfortunately, the presumed desirability of such tariffs depends crucially on assumptions that may not be fulfilled in the case of a state-owned enterprise – in particular, profit-seeking behavior on the part of the monopoly vendor and independence of consumer demand functions.

In this Article, we analyze the economic implications and potential consequences, in general, of introducing negotiated rate and service terms available to a sole user into a pre-existing regulatory regime of uniform tariff rates and conditions of service. We identify the conditions under which it is economically desirable to introduce declining-block rates or other rate structures that discriminate among users of the affected services, with or without any basis in identifiable cost differences. We address the specific economic implications and potential consequences of introducing negotiated rate and service terms available to a sole user where the affected service is provided under a monopoly established by federal statute, taking into account that such negotiated arrangements may include preferential pricing terms; that access to the negotiated terms may be limited to a small number of users for administrative or other reasons; and that competition may exist among users of the affected service or services.

Finally, we identify and describe regulatory measures that might be taken to accommodate potential concerns regarding the impact of such negotiated rate and service arrangements on fairness in regulation and competition. We conclude that it is not possible to derive sweeping propositions about the efficiency of optional tariff offerings. Instead, the welfare effects of such pricing plans must be evaluated empirically on an individual basis. Our analysis has practical significance for pricing policies in network industries, particularly those industries served by state-owned enterprises that enjoy statutory monopolies.

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