A Transactions Cost Analysis of the Welfare and Output Effects of Rebates and Non-Linear Pricing

Abstract

Ronald Coase famously exposed the limitations of economic analyses that rely upon assumptions of frictionless markets. He highlighted the importance of including transaction costs in economic analyses and issued a challenge to economists to think seriously about how transaction costs affect economic systems. Harold Demsetz, extended Coase’s analysis to show how these costs alter the way firms price and market their products. Demsetz’s analysis underscored that the costs of providing a market sometimes exceed the benefits of creating one in the first place and examined conditions where transaction costs imply that zero amounts of explicit market pricing will be efficient. This article extends Demsetz’s insights with respect to non-linear pricing contracts that seem not to “price” key side effects of the economic exchange. In particular, we analyze the welfare and output effects of two examples of such contracts that are commonly used by firms that are frequently subject to antitrust scrutiny: metered pricing; and loyalty discounts. The analysis demonstrates how a firm’s choice to set prices for its products are influenced by transaction and information costs and examines whether changes in output that are caused by the use of these non-linear pricing schemes are positively correlated with changes in total and consumer welfare. The article then discusses conditions under which measuring output effects can reliably differentiate between welfare-increasing and welfare-reducing uses of non-linear pricing.