Discussion paper

DP18374 Cost Based Nonlinear Pricing

How should a seller offer quantity or quality differentiated products if they have no information about the distribution of demand? We consider a seller who cares about the "profit guarantee" of a pricing rule, that is, the minimum ratio of expected profits to expected social surplus for any distribution of demand.
We show that the profit guarantee is maximized by setting the price markup over cost equal to the elasticity of the cost function. We provide profit guarantees (and associated mechanisms) that the seller can achieve across all possible demand distributions. With a constant elasticity cost function, constant markup pricing provides the optimal revenue guarantee across all possible demand distributions and the lower bound is attained under a Pareto distribution. We characterize how profits and consumer surplus vary with the distribution of values and show that Pareto distributions are extremal. We also provide a revenue guarantee for general cost functions. We establish equivalent results for optimal procurement policies that support maximal surplus guarantees for the buyer given all possible cost distributions of the sellers.


Bergemann, D, T Heumann and S Morris (2023), ‘DP18374 Cost Based Nonlinear Pricing‘, CEPR Discussion Paper No. 18374. CEPR Press, Paris & London. https://cepr.org/publications/dp18374