Nonlinear Pricing and Misallocation

This paper studies the effect of nonlinear pricing on markups and misallocation. We develop a general equilibrium model of firms that are allowed to set a quantity-dependent pricing schedule—contrary to the typical assumption in macroeconomic models. Without the restriction to linear pricing, markup heterogeneity is no longer a sign of misallocation. Larger firms charge higher markups, yet the allocation of resources across firms is efficient. Further, we point to a new source of misallocation. In general equilibrium, high-taste consumers are allocated too much of each good, low-taste consumers too little. When labor supply is elastic, firms’ market power depresses aggregate labor, but this effect is independent of the level of the aggregate markup in the economy. Using micro data from the retail sector, we show that nonlinear pricing is prevalent and quantify the model. We find that the welfare losses from misallocation across consumers under nonlinear pricing are substantially larger than those from misallocation across firms under linear pricing.