This paper digs into how a company with monopoly power handles the challenge of not knowing its customers’ true characteristics—whether that’s risk levels for insurance or how much they’re willing to pay for products.
Stiglitz shows that smart monopolists rarely use simple flat pricing. Instead, they create menus of options with different combinations of price, quantity, and quality. This isn’t just random variety—it’s a calculated strategy to get customers to reveal information about themselves through their choices.
The genius of this approach is that different customer types voluntarily pick different options, essentially sorting themselves into profitable categories without the company needing to directly identify who’s who. A customer choosing the high-deductible insurance plan or the economy package essentially declares “this is my type” without saying a word.
What makes this work particularly interesting is the deliberate inefficiencies built into these pricing schemes. The monopolist intentionally makes some options worse than they could be, especially those aimed at “lower value” customers, specifically to prevent “higher value” customers from choosing them instead of the pricier options designed to extract their maximum willingness to pay.
These strategic inefficiencies represent a direct tradeoff: the monopolist sacrifices some potential market efficiency to gain the ability to price discriminate more effectively.
The paper extends well beyond abstract theory, showing how this plays out in real-world insurance markets where companies offer varied combinations of premiums and deductibles that cleverly sort customers by risk level.
By connecting monopoly pricing with information problems, Stiglitz created a framework that explains why we see such complex pricing structures in markets ranging from wireless plans to airline tickets to insurance products.
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