Exploitation and Screening by Two‐Part Tariffs With Biased Beliefs of Consumers

ABSTRACT This paper examines the design of two‐part tariffs when consumers have biased beliefs about their demand. Two forms of biases are analyzed: overpessimism, where high‐valuation consumers underestimate demand, and overoptimism, where low‐valuation consumers overestimate it. With overpessimists, marginal prices for low types are distorted upward: in monopoly, due to both exploitation and the rent‐efficiency trade‐off, and in competition, solely due to exploitation. With overoptimists, firms set marginal prices for high types below cost to exploit optimism. A monopolist has incentives to educate overpessimistic consumers but may not wish to educate overoptimistic consumers. By contrast, in competition, firms lack incentives to educate any biased consumers. Debiasing policies have contrasting effects: they may reduce welfare in a monopoly but unambiguously improve welfare under competition.