Chapter 14

How does easy arbitrage affect the ability of a firm to price-discriminate? Who is more likely to get priced out of a market with easy arbitrage: those with elastic demand or those with inelastic demand?

Arbitrage makes it harder to price-discriminate, and those with elastic demand are more likely to be priced out of the market. Arbitrage is the ability of consumers in a low-price market to resell the product in a high- price market. Easy arbitrage makes impossible for firms to price-discriminate effectively. Because of this, firms, in this case, will operate like a normal monopoly and sell at only one price: the higher monopoly price. This normal monopoly price might rise above the elastic person's cutoff level, pricing consumers with elastic demand out of the market.

A dry cleaner has a sign in its window: "Free Internet coupons." The dry cleaner lists its Web site, and indeed there are good discounts available with the coupons. Most customers don't use the coupons. What is likely to be the main difference between customers who use the coupons and those who don't use them?

Consumers who use the coupons have elastic demand and consumers who don't use them have inelastic demand. Consumers with elastic demand are more sensitive to changes in the price than consumers with inelastic demand. These more price-sensitive consumers are more likely to take the time to go to the Web site and print the coupons.

The average daily demand for dinners at Paradise Grille, an upscale casual restaurant, is as follows: Demand for dinners by senior citizens: P = 50 - 0.5q; MR = 50 - Q Demand for dinners by regular diners: P = 100 - Q; MR = 100 - 2q Marginal cost = $10 in both cases Ignoring fixed costs, how much profit would Paradise Grille make if it could price-discriminate? (Hint: First, find the profit-maximizing price and quantity for each group, found in question 9. Use those to calculate total revenue.)

$2,825 They sell 40 meals at $30 each and 45 meals at $55 each for a total revenue of $3,675. The 85 total meals sold cost $10 each to make for a total cost of $850.

Assess the validity of the following statements: I. Bundling is more likely to occur in industries in which fixed costs are high and marginal costs are low. II. Bundling is more likely to occur in industries in which fixed costs are low and marginal costs are high.

Only I is true. You tend to see bundling in low-marginal-cost industries, when the business has a big incentive to add a little bit more value to the product, since for little extra cost the business can charge a much higher price. But if the marginal cost of the extra components is high, as in statement II, then bundling is less likely to occur.

Who probably has more elastic demand for a Hertz rental car: someone who reserves a car online weeks before a trip, or someone who walks up to a Hertz counter after he walks off an airplane after a 4-hour flight? Who probably gets charged more?

The person who booked in advance has a more elastic demand and will be charged less. The person who shops in advance probably has a more elastic demand: If Hertz charges too much, it's easy to go to another car rental Web site and quickly check other prices. But after a long flight, few people are willing to wait in the Hertz line, determine the price, and then jump in the National or Enterprise line and wait again. This second person probably gets charged more as a result of not wanting to wait in every other rental companies' lines.

what 4 types of markets is price discrimination common in?

-Different prices in different markets -Perfect price discrimination -Tying -Bundling

When is a pharmaceutical company more likely to spend $100 million to research a new drug: when it knows it will be able to charge different prices in different countries or when it knows that it will be required to charge the same price in different countries? Why?

It will spend that much research money when it knows it will be able to charge different prices in different countries, because this would lead to higher profits. When a firm is able to price-discriminate, or charge different prices to different customers, it earns a higher profit than when it charges a single price.

Some people think that business create monopolies by destroying their competition, and there is certainly some truth to that. But as we learned from Obi-Wan Kenobi,"[Y]ou will find that many of the truths we cling to depend greatly on our own point of view." For instance, some people (convenience shoppers) love shopping at one particular store and will only switch stores when the product they want is outrageously expensive, while other people (bargain shoppers) will gladly spend hours looking through newspaper advertisements searching for the best deal. When both these kinds of people are shopping at the same Walmart, how would you describe Walmart's power over each?

Walmart has monopoly power over convenience shoppers. Walmart has monopoly power over convenience shoppers: They will buy whatever looks good. Walmart will have little power over bargain shoppers. When these shoppers walk into Walmart, they only "see" the goods with the competitive prices. This means that the same shop can simultaneously be a "monopolist" to some customers and a "competitive firm" to others.

The average daily demand for dinners at Paradise Grille, an upscale casual restaurant, is as follows: Demand for dinners by senior citizens: P = 50 - 0.5q; MR = 50 - Q Demand for dinners by regular diners: P = 100 - Q; MR = 100 - 2q Marginal cost = $10 in both cases If you owned this restaurant, what "Senior Citizen Discount" would you offer? (Hint: Use the profit- maximizing price for each group from the previous question to calculate the percentage discount for senior citizens.)

45% You'd offer a (55 - 30)/55 = 45% discount to seniors.

Assess the validity of the following statements. I. A price-discriminating business will be willing to spend money to make a product better. II. A price-discriminating business will be willing to spend money to make a product worse.

Both I and II are true. Quality differences are one way that producers work to separate different types of consumers. Thus, firms would be willing to spend money to increase quality or to decrease quality. If you think this is far-fetched, read the textbook section titled "Price Discrimination Is Common" and the story about IBM printers for a real-life example.

Assess the validity of the following statements. I. Price discrimination is more likely to occur in monopoly-type markets than in competitive markets. II. A monopoly will create more output when it's allowed to perfectly price-discriminate compared with when the government bans price discrimination.

Both I and II are true. Statement I is true because in competitive markets if one firm tried to price-discriminate, another firm would just jump in and offer a lower, but still profitable, price. The power of free entry— key to a competitive market—makes it much harder to lump customers into different price- discrimination categories. Statement II is true because perfectly price-discriminating monopolies actually produce the efficient quantity. This is because PPD monopolies don't face the typical downward-sloping marginal revenue curve of a single-price monopoly, so they will produce until P = MC.

Two customers, Fred and Lamont, walk into a Grady's Used Pickups. Lamont is good at shopping around, but Fred knows what he likes and just buys it. Who probably has a more inelastic demand for one of Grady's pickups?

Fred's demand is more inelastic. People like Fred, who make quick, impulsive decisions, have inelastic demand. They don't shop around much and aren't very sensitive to price. Customers like Fred are every business owner's dream.

A business that price-discriminates will generally: I. charge some customers higher prices than other customers. II. charge some customers more than marginal cost, and charge other customers less than marginal cost.

Only I is true. A price discriminator does charge different prices to different groups, but price discrimination has little to do with charging less than marginal cost. The goal is to charge some customers a little more than MC and others a lot more than MC.

is when you charge more than one price for the same product. it can increase surplus as compared to simple monopoly

price discrimination

Did firms find it easier to price-discriminate before the existence of eBay or after? Which of the two "principles of price discrimination" does this stem from?

before; arbitrage. eBay has made price discrimination more difficult because it makes it easy for people who "buy cheap" to resell their products anonymously. This difference stems from the fact that eBay makes arbitrage easier. Arbitrage must be difficult for price discrimination to work.

The average daily demand for dinners at Paradise Grille, an upscale casual restaurant, is as follows: Demand for dinners by senior citizens: P = 50 - 0.5q; MR = 50 - Q Demand for dinners by regular diners: P = 100 - Q; MR = 100 - 2q Marginal cost = $10 in both cases What is the profit-maximizing price for each group?

P = $30 for senior citizens and $55 for regular diners To find the profit-maximizing price for each group, set MC = MR in each case, and solve for the profit-maximizing quantity. Doing so will reveal that you should sell 40 meals to seniors (10 = 50 - Q) and 45 meals to regular diners (10 = 100 - 2q). To find the price for each group, you must substitute the quantity for each group into that groups demand function. Doing so will reveal that the price for senior citizens should be $30 (P = 50 - 0.5 × 40) and the price for regular diners should be $55 (P = 100 - 45).

As we saw in this chapter, drug companies often charge much more for the same drug in the United States than it does in other countries. Congress often considers passing laws to make it easier to import drugs from these low-price countries. If one of these laws passes, and it becomes effortless to buy AIDS drugs from Africa or antibiotics from Latin America—drugs that are made by the same companies and have essentially the same quality controls as the drugs here in the United States—how will drug companies change the prices they charge in Latin America and Africa? Why?

Prices in Latin America and Africa will rise. The equilibrium price will rise in Latin America and Africa, because the drug companies will know that much of what they send there will wind up back in the United States. In essence, the drug companies will return to being single-price monopolists.

Some razors, like Gillette's Fusion and Venus razors, have disposable heads. The razor comes with an initial pack with a razor handle plus three or four heads; after that, you need to buy refills separately. What would you call this form of price discrimination? Where do you think Gillette gets more revenue?

tying; Gillette gets more revenue from the refills. This type of price discrimination where an initial purchase is tied to subsequent purchases (like a printer and ink) is called tying. In this type of price discrimination the price of the initial (base) good is set low to draw consumers into the product which then requires subsequent purchases of a "variable" good. Using this model, Gillette gets a great deal more revenue from selling the refills, as a typical person will spend much more money on refills than on the original razor handle. So, if you want to make a rational purchase decision the next time you buy a razor, you should pay more attention to the price of the refills than the price of the initial razor.

In many of our price discrimination examples, we think that businesses try to break customers into two groups: more price-sensitive and less price-sensitive. Consider the market for lunches in restaurants. Which of the following examples are likely to fit into the first group? I. Busy lawyers with 20-minute lunches II. College students III. Health-conscious soccer moms IV. Long-haul truck drivers

college students and long-haul truck drivers College students are likely to be price-sensitive because they have less disposable income, and the opportunity cost of searching for cheaper alternatives is low for them. Long-haul truck drivers are likely to be less price-sensitive because they often encounter many different restaurants as they drive, or in other words, they have many available substitutes.