Competitive Screening of Customers with Non-Common Priors

Publication Date
Systemic Risk Centre Discussion Papers DP 73
Publication Authors

This paper provides an explanation for the variety of contracts offered by competitive firms for seemingly identical products or services. I show that two competing firms offering menus of non-linear price schedules to customers with biased beliefs about their future demand will be able to screen these customers on the basis of their priors. Firms’ use of menus of tariffs can thus be understood as screening devices for boundedly rational consumers. However, while such menus allow firms to screen their customers according to their ability to correctly forecast future demand, they do not allow them to extract additional rents provided the market is sufficiently competitive and firms’ have identical priors concerning their customers’ types. Sufficiently strong competition guarantees that each tariff only covers the fixed costs of the firm. Competition between firms however cannot remedy the bias in consumers’ beliefs about their future demand.