Differential pricing when costs differ: a welfare analysis

This article analyzes the welfare effects of monopoly differential pricing in the important, but largely neglected, case where costs of service differ across consumer groups. Cost-based differential pricing is shown to increase total welfare and consumer welfare relative to uniform pricing for broad classes of demand functions, even when total output falls or the output allocation between consumers worsens. We discuss why cost-based differential pricing tends to be more beneficial for consumers than its demand-based counterpart, third-degree price discrimination. We also provide sufficient conditions for welfare-improving differential pricing when costs and demands differ across consumer groups.