EC 201 Lecture Notes - Lecture 16: Price Discrimination, Economic Surplus, The Dilemma

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9 Mar 2018

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Economics 201 lecture 16 monopoly continued; Two ways of price discriminating: a monopoly can discriminate, among groups of buyers (advance purchase and other restrictions on airline tickets are an example, among units of a good (quantity discounts are an example. But quantity discounts that reflect lower costs at higher volumes are not price discrimination) Increasing profit and producer surplus: by price discriminating, a monopoly captures consumer surplus and converts it into producer surplus, more producer surplus means more economic profit. In the prisoners" dilemma game, two prisoners (art and bob) have been caught committing a petty crime. If one of them confesses, he will get a 1 year sentence for cooperating while his accomplice will get a 10 year sentence for both crimes. If both confess to the more serious crime each receives a 3 year sentence for both crimes. If neither confesses, each receives a 2 year sentence for the minor crime only.

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Professional baseball teams earn substantial revenues through ticket sales. To maximize profit, they offer significantly lower ticket prices for children (whose demand is elastic) than for adults (whose demand is inelastic). This discount may be as much as 50 percent.

If this type of price discrimination increases revenue and profit, why don't teams also price discriminate at the concession stands? Why don't they offer half-price hot dogs, soft drinks, peanuts, and Cracker Jack to children?

The answer involves the three requirements for successful price discrimination. All three requirements are met for game tickets: (1) The team has monopoly power; (2) it can segregate ticket buyers by age group, each group having a different elasticity of demand; and (3) children cannot resell their discounted tickets to adults.

It's a different situation at the concession stands. Specifically, the third condition is not met. If the team had dual prices, it could not prevent the exchange or resale of the concession goods from children to adults. Many adults would send children to buy food and soft drinks for them: Here's some money, Billy. Go buy six hot dogs. In this case, price discrimination would reduce, not increase, team profit. Thus, children and adults are charged the same high prices at the concession stands. (These prices are high relative to those for the same goods at the local convenience store because the stadium sellers have a captive audience and thus considerable monopoly power.)

Finally, price discrimination often occurs in international trade. A Russian aluminum producer, for example, might sell aluminum for less in the United States than in Russia. In the United States, this seller faces an elastic demand because several substitute suppliers are available. But in Russia, where the manufacturer dominates the market and trade barriers impede imports, consumers have fewer choices and thus demand is less elastic.

First, give your own thoughts on the above analysis of the concept of Price Discrimination. Second, give some concrete examples from your own life where you have been confronted by situations of Price Discrimination. Finally are there some forms of Price Discrimination that should be illegal?

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PLEASE ANSWER EACH QUESTION WITH A, B, C, and D. NOT ANSWERING ALL QUESTIONS OR INCORRECT ANSWERS WILL RESULT IN A THUMBS DOWN.

Question 1: Which of the following is not needed for price discrimination to be possible?

		A. The firm must have market power.
		B. The firm must be able to prevent resale and arbitrage.
		C. The firm must eventually learn about its customers' demands.
		D. The firm's customers must have different demand curves.

Question 2: Relative to standard monopoly pricing, first-degree price discrimination results in:

	A.	higher consumer surplus, higher producer surplus, and higher total surplus.
	B.	lower consumer surplus, higher producer surplus, and higher total surplus.
	C.	lower consumer surplus, higher producer surplus, and lower total surplus.
	D.	lower consumer surplus, lower producer surplus, and lower total surplus.

Question 3: Relative to perfect competition, first-degree price discrimination results in:

		A. higher consumer surplus, higher producer surplus, and higher total surplus.
		B. lower consumer surplus, higher producer surplus, and equal total surplus.
		C. lower consumer surplus, higher producer surplus, and equal total surplus.
		D. lower consumer surplus, lower producer surplus, and lower total surplus.

Question 4: If market demand is P = 100 - Q and the firm has a constant marginal cost of 20, then with first-degree price discrimination, the firm's producer surplus will be:

A.	$800.
B.	$1,600.
C.	$2,400.
D.	$3,200.

Question 5: For third-degree discrimination to be possible, which of the following features is not required?

		A. market power
		B. prevention of resale
		C. identification of each customer's demand before purchase
		D. customers with different demand curves

Question 6: A golf course has frequent players whose demand is Q_f = 260 - 0.4P and infrequent players whose demand is Q_i = 10 - 0.1P. The combined market demand is Q = 34 - 0.4P. The marginal cost and average total cost of providing a round of golf are $20. How much higher will the profit be if the golf course uses third-degree price discrimination instead of charging all golfers the same price?

A.	$0
B.	$7.50
C.	$10
D.	$110

Question 7: An airline sells seats on its flights to business travelers whose demand is Q_B = 300 - P and vacation travelers whose demand is Q_V = 150 - 0.5P. The combined market demand is Q = 450 - 1.5P. The marginal cost and average total cost of providing a seat on a flight are $200. How much higher will profit be if the airline uses third-degree price discrimination instead of charging all travelers the same price?

A.	$0
B.	$250
C.	$400
D.	$1,000

Question 8: If a firm practices third-degree price discrimination, the price charged should be higher in the market where demand is:

	A.	Higher.
	B.	Lower.
	C.	More price elastic.
	D.	Less price is elastic.

Question 9: The key difference between markets where third-degree price discrimination is possible and markets where second-degree price discrimination is possible is whether:

		A. resale is possible.
		B. customers have the same demand curves.
		C. firms have market power.
		D. firms can identify customers' demand before the customers make a purchase.

Question 10: For price discrimination via a quantity discount to work:

		A. customers who purchase larger quantities must have relatively elastic demand.
		B. customers who purchase larger quantities must have relatively inelastic demand.
		C. customers who pay a relatively high price must have relatively elastic demand.
		D. customers who pay a relatively low price must have relatively inelastic demand.

Question 11: A firm wants to offer a quantity discount to price-discriminate between buyers who are relatively uninterested in the product and buyers who are obsessively interested in it. The uninterested customers have a demand of Q_U = 30 - 0.5P. The package offered to them contains 10 units of the good at a price of $40 each. Which of the following packages designed for obsessed customers is incentive compatible?

	A.	60 units at a price of $10 each
	B.	40 units at a price of $10 each
	C.	60 units at a price of $20 each
	D.	40 units at a price of $20 each

Question 12: Which of the following conditions do not have to be met in order for indirect price discrimination by versioning to work?

		A.The firm's customers must have different demand curves.
		B. The marginal costs of producing each version of the product must be the same.
		C. The firm must be able to prevent resale.
		D. The firm must have market power.

	Willingness to pay (per month)
	Weight machines	Indoor pool
Abe	$60	$50
Betty	50	125
Chris	25	140

QUESTION 13
This table shows the willingness to pay off the only three potential customers of a firm that runs both a weight room and an indoor swimming pool. The weight room and pool each have a constant marginal cost of $20 per month. Which of the following pricing strategies yields the highest producer surplus?

		A. $60 for the weight room, $140 for the pool, or $175 for both
		B. $50 for the weight room, $125 for the pool, or $165 for both
		C. $25 for the weight room, $50 for the pool, or $70 for both
		D. $60 for the weight room, $130 for the pool, or $175 for both

Question 14: Which of the following features is needed to make bundling a possible price discrimination strategy but is not required for any other price discrimination strategies?

		A. Customers must have identical demand curves.
		B. The firm does not learn about customer demand until after purchase.
		C. Demand for two products must be negatively correlated.
		D. The firm must not have market power.

Question 15: Which of the following features is not needed for price discrimination using a two-part tariff to work?

		A. The firm must have market power.
		B. The firm must be able to prevent resale.
		C. The firm must learn about its customers' demands before purchases are made.
		D. The firm's customers must have different demand curves.

Question 16: A firm faces a market demand curve P = 50 - 5Q. It has a constant marginal cost of $10. Relative to standard monopoly pricing, how would a block pricing strategy where the first four units can be purchased for a price of $30 each, but two more units can be purchased for an additional $20 each change consumer surplus and producer surplus?

		A. Consumer surplus would decrease by $10, and producer surplus would increase by $20.
		B. Consumer surplus would increase by $10, and producer surplus would increase by $20.
		C. Consumer surplus would increase by $20, and producer surplus would increase by $10.
		D. Consumer surplus would increase by $20, and producer surplus would increase by $20.

Question 17: Relative to standard monopoly pricing, block pricing:

		A. decreases consumer surplus, increases producer surplus, and increases total surplus.
		B. increases consumer surplus, increases producer surplus, and increases total surplus.
		C. decreases consumer surplus, increases producer surplus, and decreases total surplus.
		D. decreases consumer surplus, decreases producer surplus, and decreases total surplus.

Question 18: Which of the following results in the highest amount of producer surplus?

	A.	bundling
	B.	third-degree price discrimination
	C.	block pricing
	D.	two-part tariffs

Question 19: Which of the following results in the highest amount of consumer surplus?

	A.	first-degree price discrimination
	B.	third-degree price discrimination
	C.	block pricing
	D.	two-part tariffs

Question 20: Which of the following results in the highest amount of total surplus?

	A.	third-degree price discrimination
	B.	block pricing
	C.	first-degree price discrimination
	D.	bundling

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EC 201 Lecture Notes - Lecture 16: Price Discrimination, Economic Surplus, The Dilemma

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