Market Separation, Negative Consumption Externalities and Capacity Constraints

Abstract

Companies that offer services with capacity constraints in which there are negative consumption externalities (such as restaurants that serve smokers and non-smokers, airlines that fly passengers traveling with infants and without infants or organizers of sport events that serve aggressive and friendly supporters) tend to separate generators of the externality from receptors of the externality. Do consumers and/or Society end better off with this type of separation? We show that if firms have complete information then: unless the number of consumers is small enough, as a net effect, consumers end worse off with separation than without it. Instead, when investment in separation is negligible, firms always prefer separation. This is true regardless whether firms price discriminate consumers. On the other side, if firms have incomplete information then: consumers prefer no separation if their number is small enough and firms always prefer no-separation -- also when investment in separation is negligible. First we derive the results in the context of a monopoly that serves a linear demand, later we address robustness and discuss policy implications.

Keywords: Optimal prices, welfare analysis, capacity constraints, negative consumption externality, market separation.

JEL Classification: L4, L5, L8