Internet Service Pricing: Flat or Volume?

In this paper, we study the pricing of Internet services under monopoly and duopoly environments using an analytic model in which a service provider and users try to maximize their respective payoffs. We compare a few popular pricing schemes, including flat, volume-based, two-part, and nonlinear tariffs, with respect to revenue, social welfare, and user surplus. We perform a study of the sensitivity of these schemes to the estimation errors. In the duopoly situation, we formulate a simple normal form game between two service providers and study their equilibrium behaviors. Our main findings include: (1) the flat pricing generates higher revenue than the pure volume pricing when the elasticity of demand is low; (2) the volume-based pricing is better for society and users than the flat pricing regardless of the elasticity; (3) the market is segmented into two when one provider provides flat pricing and another provides volume based pricing.