Second-degree Price Discrimination: Theoretical Analysis, Experiment Design, and Empirical Estimation

We propose an empirical model of second-degree price discrimination (2PD) that closely follows the theoretical literature on screening. Crucially, our model captures the covariance, across con- sumers, between the “baseline” willingness to pay (affecting all product versions) and the perceived differentiation between versions. While essential in determining the shape of the optimal 2PD mech- anism, this covariance is challenging to identify in settings with aggregate data and a small number of products/versions, typical of 2PD environments. We develop an experimental framework that resolves these identification challenges. Our experimental-econometric methodology, hence, allows mechanism designers to empirically solve for optimal 2PD mechanisms in a wide range of applications where the differentiation between product versions is based on quality, quantity, timing of purchase, etc. We demonstrate the applicability of our framework by implementing it in the context of seat selection for flights in collaboration with an international airline.