Exploring Price Discrimination

4. Answer the following questions based on the following table, which contains cost and demand data for a monopolist.

Marginal Cost
Price Consumers Will Pay
Marginal Revenue
1 (first)

2 (second)

3 (third)

4 (fourth)

5 (fifth)

6 (sixth)

7 (seventh)

8 (eighth)

a) If the price of this good is set at $7.40, what will the size of the consumer surplus be?
b) If this firm can charge only one price, what amount will it produce to maximize profits? (Hint: You need to compute marginal revenue.)
c) What price will it charge?
d) What is the size of the consumers' surplus in this case?
e) How much of the consumer surplus from part a does the monopolist capture in this case?
f) Explain why this result will not be economically efficient.
g) If this firm can price-discriminate perfectly, how much will it produce?
h) Explain why this result will be economically efficient.

5. A firm can produce one million light bulbs at a total cost of $1,000,000. It sells them for $1.10 each, making a profit of ten cents per bulb. One of the executives finds that if they produce two million bulbs, total cost rises to $1,500,000. This executive also finds that the company can sell these light bulbs abroad for $.65 each. He argues that the firm should expand production and sell the extra bulbs abroad. Other executives argue that this plan is nonsense. They point out that if the firm produces two million bulbs, the average cost per bulb is $.75. They state that no company can make a profit by selling its product for less than the cost of production.

Who is right in this case? Explain.

6. In order to price-discriminate, a seller must be able to separate its market into two parts. One part must contain those who are sensitive to price, and the other must contain those who are not. Explain how each of the following strategies separates buyers into these two groups:

a) A home computer maker offers a $50.00 discount to any buyer who trades in another home computer or video game.
b) Movie theaters charge a reduced admission for children under 12.
c) Grocery stores charge lower prices on some items if people have coupons that they clipped from the paper.
d) Colleges that are prestigious and expensive give scholarships on the basis of need.
e) Colleges that are not prestigious and not expensive give scholarships on the basis of academic ability.
f) Economics journals charge libraries higher subscription rates than they charge individuals.
g) The American Economic Association has membership rates that are higher for those who earn large incomes than for those who earn small incomes.

7. One of the most recognized names on the Internet is Priceline.com. It owes its success entirely to price discrimination.
Log onto <http://www.priceline.com/> and see how you would use it to buy airline tickets.
A key to effective price discrimination is to separate people willing to pay a lot for a good or service from those willing to pay only a little. Why would a person willing to pay a lot for an airline ticket be unlikely to buy it on Priceline.com? (Hint: What are the conditions Priceline imposes? Why are they imposed?)
Can you find any indication of how they decide which prices to accept and which to reject?
Why does Priceline offer the assortment of items that it does? Why does it not offer a different assortment of goods and services?
What prevents other companies from doing what Priceline does?

8. You are working for a small museum that is struggling to survive. Their daily costs of staying open are $350 per day, and it does not matter how many people come. The museum tried charging a low entry fee of $3 and attracted an average of 100 people per day. They then decided to charge more, $10, but only attracted 30 people per day. They noticed at the higher price, they lost almost all visitors with children, but kept almost all the older visitors. What would you advise them to try next? Explain.

9. Several years ago, Amazon.com was accused of "dynamic pricing." Search the Internet for "dynamic pricing" and explain what they were supposedly trying to do.

10. Search the Internet for the terms {"international editions" textbooks} and {"gray market" textbooks}. You should find an example of price discrimination. Explain what is going on.

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