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12.3 SECOND-DEGREE PRICE DISCRIMINATION: QUANTITY DISCOUNTS 495
In many markets each consumer buys more than one unit of the good or service in a 12.3

given time period. For example, each month consumers buy many units of electricity SECOND-
and water. People who commute to work on mass transit systems make many trips a
month. And many airline travelers are frequent flyers. DEGREE PRICE
Sellers know that each customer’s demand curve for a good is typically downward DISCRIMI-
sloping. In other words, the customer’s willingness to pay decreases as successive units NATION:
are purchased. A seller may use this information to capture extra surplus by offering
quantity discounts to consumers. QUANTITY
However, not every form of quantity discounting represents price discrimination. DISCOUNTS
Often sellers offer quantity discounts because it costs them less to sell a larger quan-
tity. For example, a pizza that serves four people usually sells for less than twice the
price of a pizza for two people. Labor, cooking, and packaging costs are not very sen-
sitive to the size of the pizza. The pricing reflects the fact that the cost per ounce is
lower for a large pizza.
What, then, characterizes quantity discounting with second-degree price discrim-
ination? One distinguishing feature of second-degree price discrimination is that the
amount consumers pay for the good or service actually depends on two or more
prices. For example, many consumers buy their telephone service under a multipart
tariff (a tariff, or price, that consists of two or more separate prices). Thus, you might
pay a price of $20 a month (a subscription charge) just to be hooked up to the telephone
system, even if you never make a call. In addition, you might pay another price of
5 cents per call for local calls (a usage charge).
In this section we will consider two different ways in which sellers can use quan-
tity discounting to capture surplus. First, we will look at block pricing (like the soft-
ware firm’s pricing system for computer games, discussed in Section 12.1). We will
then take a more detailed look at pricing with subscription and usage charges.

BLOCK PRICING

Suppose there is only one consumer in the market for electricity. The consumer’s
demand curve and the marginal cost curve are the same as in Figure 12.3: Demand is
P 20 Q and marginal cost is MC 2, as shown in Figure 12.4. As we saw in
Learning-By-Doing Exercise 12.1, with uniform pricing, the price that maximizes
profit is P $11 per unit of electricity. At this price, the consumer buys 9 units, and
the firm captures a producer surplus of $81.
Now suppose that the firm offers a quantity discount—for example, charging $11
per unit for the first 9 units the consumer buys and $8 per unit for any additional
units. As we can see in Figure 12.4, in this situation the consumer will buy 3 additional
units, for a total of 12 units, and the firm will capture additional producer surplus of
$18 (area JKLM ), for a total producer surplus of $99. block tariff A form of
This pricing schedule is an example of a block tariff. (It is a kind of multipart tar- second-degree price dis-
iff because it consists of two prices, one price for the first 9 units and another price for crimination in which the
additional units.) We can see that this type of quantity discounting represents second- consumer pays one price
degree price discrimination because the firm’s marginal cost is constant at 2—that is, for units consumed in the
it doesn’t cost the firm less to sell a larger quantity (unlike in the pizza example dis- first block of output (up to
cussed above). a given quantity) and a
different (usually lower)
Now we can ask: What is this firm’s optimal block tariff (the block tariff that max- price for any additional
imizes producer surplus)? For simplicity’s sake, we’ll assume that the firm’s tariff will units consumed in the
consist of only two blocks. second block.