SECOND DEGREE PRICE DISCRIMINATION AND NATURAL MONOPOLY Alfons J. Weichenrieder Goethe University Frankfurt & CESifo ABSTRACT This paper considers the efficiency of a contestable natural monopoly if consumers are heterogeneous and the monopolist can differentiate prices imperfectly. The paper shows that a ‘‘no-distortion-at-the-top’’ result, which is standard in models with restricted entry, may also appear in a contestable market. Depending on cost and demand structures, first best efficiency can also be a sustainable equilibrium. However, due to the existence of a continuum of equilibria, first best efficiency is not guaranteed. Most notably, even a stable ‘‘distortion- at-the-top’’ result is possible. Keywords: natural monopoly, contestability, contract theory JEL classification numbers: D42, D82 I. INTRODUCTION In markets where resale by consumers is difficult or impossible, price differentiation between consumers is a frequent empirical phenomenon. Examples of prices which depend on the quantity purchased (non-linear prices) can be found in the electricity and airline industries, in telephone services, in insurance and in many other areas. A great deal of theoretical analysis has been devoted to such pricing strategies. The focus of most Correspondence: Goethe University Frankfurt & CESifo, Mertonstr. 17, 60054 Frankfurt (Main), Germany. E-mail: a.weichenrieder@em.uni-frankfurt.de. I thank Geir Asheim and Marcel Thum for valuable discussion and an anonymous referee for helpful comments. All remaining errors are mine. # Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research 2004. Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA Bulletin of Economic Research 56:2, 2004, 0307–3378 189