Second Degree Price Discrimination for Information Goods under Nonlinear Utility Functions

This paper studies second degree price discrimination for information goods. Prior research in the context of traditional goods (where marginal costs are convex as a function of product quality) shows that a firm can increase profits by offering vertically differentiated products to heterogeneous consumers. Some researchers have obtained the converse result for information products, assuming negligible marginal costs which vary little with product quality. Earlier models have used specific forms of the consumer utility function (most commonly a utility function that is linear in type and product quality). We model this problem using a generalized utility function where the utility is monotonically increasing with product quality and consumer type. We find that for information goods, price discrimination is profitable only in markets where high-value consumers benefit relatively more than low-value consumers from increases in quality.