Document Type
Discussion Paper
Publication Date
2-11-2025
CFDP Number
2425
CFDP Pages
43
Journal of Economic Literature (JEL) Code(s)
D47, D82, D83
Abstract
We develop an economic framework to analyze the optimal pricing and product design of Large Language Models (LLM). Our framework captures several key features of LLMs: variable operational costs of processing input and output tokens; the ability to customize models through fine-tuning; and high-dimensional user heterogeneity in terms of task requirements and error sensitivity. In our model, a monopolistic seller offers multiple versions of LLMs through a menu of products. The optimal pricing structure depends on whether token allocation across tasks is contractible and whether users face scale constraints. Users with similar aggregate value-scale characteristics choose similar levels of fine-tuning and token consumption. The optimal mechanism can be implemented through menus of two-part tariffs, with higher markups for more intensive users. Our results rationalize observed industry practices such as tiered pricing based on model customization and usage levels.
Recommended Citation
Bergemann, Dirk; Bonatti, Alessandro; and Smolin, Alex, "The Economics of Large Language Models: Token Allocation, Fine-Tuning, and Optimal Pricing" (2025). Cowles Foundation Discussion Papers. 2834.
https://elischolar.library.yale.edu/cowles-discussion-paper-series/2834
