Econ 321 test #3
Which of the following is not an example of price discrimination?
Charging young men more than young women for auto insurance.
Suppose a firm faces an identical inverse demand curve of p=160−q for each consumer in the market. Currently, the firm's average cost = marginal cost = $30. Determine the profit-maximizing price and identical lump-sum fee to charge with a two-part tariff The profit-maximizing price to charge is $ The profit-maximizing lump-sup fee to charge is $
30 8450
Joe has just moved to a small town with only one golf course, the Northlands Golf Club. His inverse demand function is p=180−2q, where q is the number of rounds of golf that he plays per year. The manager of the Northlands Club negotiates separately with each person who joins the club and can therefore charge individual prices. This manager has a good idea of what Joe's demand curve is and offers Joe a special deal, where Joe pays an annual membership fee and can play as many rounds as he wants at $40, which is the marginal cost his round imposes on the Club. What membership fee would maximize profit for the Club? The manager could have charged Joe a single price per round. How much extra profit does the Club earn by using two-part pricing? The profit-maximizing membership fee (F) is $
4900 The Club's extra profit is 2450
Which of the following conditions must be true so that a firm can price discriminate?
A. The good cannot be easily resold.
Only Native American Indian tribes can run casinos in California. These casinos are spread around the state so that each one is a monopoly in its local community. California governor Arnold Schwarzenegger negotiated with the state's tribes, getting them to agree to transfer 10% of their profits to the state in exchange for concessions. How does a profit tax affect a monopoly's output and price? How would a monopoly change its behavior if the profit tax were 25% rather than 10%? (Hint: You may assume that the profit tax refers to the tribe's economic profit.)
A. The tax has no effect on price and quantity; thus, changing the tax rate also has no effect.
Suppose a firm faces an identical inverse demand curve of p=160−q for each consumer in the market. Currently, the firm's average cost = marginal cost = $20. Determine the profit-maximizing price and identical lump-sum fee to charge with a two-part tariffLOADING.... The profit-maximizing price to charge is The profit-maximizing lump-sup fee to charge is
$20 $9800
How much is the consumer surplus? How much is the producer surplus? How much is the deadweight loss? Monopoly total surplus is __________ competitive total surplus
$450 $1350 $225 less than
Can the table below be modified so that the movie theater earns more from charging a single price than by perfectly price discriminating The theater price discriminates by charging college students $10 and senior citizens $5. College students go to the theater if they are charged no more than $10. Senior citizens are willing to pay up to $5. The theater's marginal cost for an extra customer is $0. What changes to the table would increase the extra profit from perfectly price discriminating? The extra profit from perfect price discrimination
No change can be made such that profit from charging a single price is greater. would increase if the reservation prices of college students and seniors were more different.
The inverse demand curve a monopoly faces is p=130−Q. The firm's cost curve is C(Q)=10+5Q. What is the profit-maximizing solution? What is the firm's economic profit? How does your answer change if C(Q)=150+5Q? The increase in fixed cost
Q*= 62.5 P*= 67.5 profit = 3,896.25 -has no effect on the equilibrium price and quantity, but profit will decrease.
College students could once buy an IBM or other PC computer (e.g. Dell) at a substantial discount through a campus buying program. The discounts largely disappeared in the late 1990s, when PC companies dropped their prices. "The industry's margins just got too thin to allow for those [college discounts]," said the president of Educause, a group that promotes and surveys using technology on campus. Using the concepts and terminology discussed in this chapter, explain why shrinking profit margins are associated with the reduction or elimination of student discounts. Currently, Apple offers college students discounts on computers, often bundled with a printer, an iPod or other Apple product. Why is Apple more likely to offer discounts to students than other computer companies? Unlike Apple, which still offers students discounts, Dell has become less likely to price discriminate by offering student discounts because
Dell has less market power
Are major-league baseball clubs profit-maximizing monopolies? Some observers of this market have contended that baseball club owners want to maximize attendance or revenue. Alexander (2001) says that one test of whether a firm is a profit-maximizing monopoly is to check whether the firm is operating in the elastic portion of its demand curve Why is that a relevant test? What would the elasticity be if a baseball club were maximizing revenue?
If a firm were operating in the inelastic portion of the demand curve, it could raise its price and increase profit. Revenue is maximized when elasticity equals −1.
A monopoly sells its good in the U.S. and Japanese markets. The American inverse demand function is pa=110−Qa, and the Japanese inverse demand function is pj=90−2Qj, where both prices, pa and pj, are measured in dollars. The firm's marginal cost of production is m = $20 in both countries. If the firm can prevent resales, what price will it charge in both markets?
Japan = 55 US = 65
A monopoly sells its good in the U.S. and Japanese markets. The American inverse demand function is pa=120−Qa, and the Japanese inverse demand function is pj=100−2Qj, where both prices, pa and pj, are measured in dollars. The firm's marginal cost of production is m = $15 in both countries. If the firm can prevent resales, what price will it charge in both markets?
Japan = 57.5 US= 67.5
When the iPad was introduced, Apple's constant marginal cost of producing this iPad was about $220. We estimate that Apple's inverse demand function for the iPad was p=770−11Q, where Q was the millions of iPads purchased. In turn, Apple's profit-maximizing quantity was Q=25 million iPads and its profit-maximizing price was p=$495 per unit. What was the Lerner Index for the iPad? If Apple were profit maximizing, what price elasticity of demand did it face? The Lerner Index was The price elasticity of demand at the profit-maximizing price and quantity was
L=0.56 (p-MC)/p ε=-1.8 (slope x p/q)
If the linear inverse demand function is p=100−5Q, what is the marginal revenue function? Draw the demand and marginal revenue curves. The marginal revenue (MR) function is
MR = 100-10Q -derivative of R equation (PxQ) -MR curve is same P as Demand curve, but half the Q
Consumer surplus will always equal deadweight loss when demand is linear and marginal cost is constant because
MR has twice the slope of D and intersects MC halfway between 0 and the quantity at eC.
Suppose that the demand curve for wheat is Q=100−10p and the supply curve is Q=10p. The government imposes a specific tax of τ=1 per unit. a. How do the equilibrium price and quantity change? (Round quantities to the nearest integer and round prices to the nearest penny) The equilibrium quantity without the specific tax is What effect does this tax have on consumer surplus, producer surplus, government revenue, welfare, and deadweight loss?
Q without tax = 50 P without tax = 5 Q with tax = 45 P with tax = 5.5 Government revenue (T) is $45 The deadweight loss (DWL) is $2.5
The inverse demand curve a monopoly faces is p=100−Q. The firm's cost curve is C(Q)=20+5Q. What is the profit-maximizing solution? What is firms economic profit? How does your answer change if C(Q)=100+5Q?
Q*=47.5 P*=52.5 profit= 2,236.25 The increase in fixed cost has no effect on the equilibrium price and quantity, but profit will decrease.
The inverse demand curve a monopoly faces is p=110−2Q. The firm's cost curve is C(Q)=10+6Q. What is the profit-maximizing solution? The profit-maximizing quantity is The profit-maximizing price is
Q=26 P=58 profit = 1342
A demand curveLOADING..., Q=16p, has the property that the elasticityLOADING... of demand is ε=−1. Use math to show that the revenue is the same at any given point on the constant elasticity of demand curve. At any point on the constant elasticity of demand curve, revenue is Show that, for any point on the constant elasticity of demand curve, the corresponding marginal revenue is zero. At any point on the constant elasticity of demand curve, marginal revenue is zero because
R=$16 ΔR/ΔQ=0
Which of the following explains why a two-part tariff causes customers who purchase few units to pay more per unit than customers who buy more units?
The average per-unit price is constant while the average lump-sum fee decreases as the quantity purchased increases. Your answer is correct.
Recalling the information from the "Botox Patent Monopoly" application, inverse demand was p=775−375Q, marginal revenue was MR=775−750Q, marginal cost was MC=25, a constant, and quantity is in millions of units. What would happen to the equilibrium price and quantity if the government had set a price ceiling of $225 per vial of Botox? What welfare effects would the price ceiling have? The deadweight loss (DWL) is
The equilibrium price would be $225. The equilibrium quantity would be 1.47 million units. DWL= $54.00 million.
Recalling the information from the "Botox Patent Monopoly" application, inverse demand was p=800−375Q, marginal revenue was MR=800−750Q, marginal cost was MC=25, a constant, and quantity is in millions of units. What would happen to the equilibrium price and quantity if the government had collected a specific tax of $50 per vial of Botox?
The equilibrium price would be $436.25 The equilibrium quantity would be 0.97 units -add tax to D equation and solve for MR=MC -find Q and plug into original inverse equation to get price DWL= 226.19 -subtract MC from equilibrium p and multiply by (MC Q - equilibrium Q) and divide by 2
Each week, a department store places a different item of clothing on sale. Which of the following is an explanation based on price discrimination for why the store conducts such regular sales?
The store attempts to sell the item to customers with relatively inelastic demand first, and then sells to customers with relatively elastic demand later. The store attempts to sell the item to customers with high reservation prices first, and then sells to customers with lower reservation prices later. A and C
A monopoly has a marginal cost of zero and faces two groups of consumers. At first, the monopoly could not prevent resales, so it maximized its profit by charging everyone the same price, p = $5. No one from the first group chose to purchase. Now the monopoly can prevent resales, so it decides to price discriminate. Will total output expand? Why or why not? What happens to profit and consumer surplus?
Total output would expand because the monopoly will lower the price to the first group, which will now purchase the good while the second group continues to purchase the same amount. This will increase both profit and consumer surplus.
Why can't a monopoly choose both price and quantity? A monopoly can't choose both price and quantity because
a monopoly has the power to set price, not the demand curve.
Suppose a utility, operating as a quantity-discriminating monopoly, offers the following block pricing. Are its customers worse off than than they would be if the firm set a single price, as illustrated in the bottom figure? The graphs represent the demand curve of an individual representative consumer. The top figure shows how the monopoly maximizes profit if it can quantity discriminate by setting two prices. The monopoly charges a price of $110 on any quantity between 1 and 40—the first block—and $70 on any units beyond the first 40—the second block. Are all of the customers worse off? Compared to when the monopoly charges a single price of $90, with the block-pricing schedule,
all of the customers are worse off because they have less surplus.
If a monopoly faces a constant elasticity of demand curve where the marginal elasticity of demand is one at every point, where would it set its price or quantity if it has a positive marginal cost The monopoly would produce
at the lowest possible quantity that is greater than zero because additional output does not increase revenue but does increase cost. situation is rare
Why do Honda service departments emphasize to customers the importance of using "genuine Honda parts" when servicing and tuning Honda cars and motorcycles? Honda emphasizes using genuine Honda parts in combination with its service offer to practice Honda is likely to be
bundling less successful if consumers do not believe using genuine Honda parts affects the reliability of their Hondas.
Can a firm operating in the upward-sloping portion of its average cost curve be a natural monopoly? Explain. A firm operating in the upward-sloping portion of its average cost curve
can be a natural monopoly if production occurs sufficiently close to the region of economies of scale.
When will a monopoly set its price equal to marginal cost? A monopoly will set its price equal to marginal cost when
consumer demand is infinitely elastic
Does a monopoly's ability to price discriminate between two groups of consumers depend on its marginal cost curve? Why or why not? Consider two cases: (a) the marginal cost is so high that the monopoly is uninterested in selling to one group; (b) the marginal cost is low enough that the monopoly wants to sell to both groups. Assume there are two groups of consumers. A monopoly's ability to price discriminate
depends on marginal cost because the monopoly will only sell to both groups if selling to each is separately profitable.
Bundling sales are most advantageous to the seller when
the demands for the two goods are negatively correlated.
If the inverse demand curveLOADING... is p=160−Q and the marginal cost is constant at $20, how does charging the monopolyLOADING... a specific tax of τ=$6 per unit affect the monopoly optimum and the welfare of consumers, the monopoly, and society (where society's welfare includes the tax revenue)? What is the incidence of the tax on consumers?
As a result of the tax, the profit-maximizing quantity decreases by 3 units and the profit-maximizing price increases by $3.00
As of 2016, the pharmaceutical companies Abbott Laboratories, AstraZeneca, Aventis Pharmaceuticals, Bristol-Myers Squibb Company, Eli Lilly, GlaxoSmithKline, Janssen, Johnson & Johnson, Novartis, Ortho-McNeil, and Pfizer provide low-income, elderly people with a card guaranteeing them discounts on many prescription medicines. Why would these firms do that?
By charging low-income seniors a lower price they can afford while continuing to charge the rest of the market the higher price, the pharmaceutical companies increase their profits.
Why might a monopoly operate in any part (downward sloping, flat, upward sloping) of its long-run average cost curve, but a competitive firm will operate only at the bottom of its long-run average cost curve? Unlike a competitive firm, a monopoly may operate on any part of its long-run average cost curve because a monopoly
is the only firm in the industry.
In 2013, the Oakland A's were one of the hottest teams in baseball. They were regularly drawing "sellout" crowds, with many more fans wanting tickets. However, the A's did not sell all of the 56,000 seats. The A's removed or put tarps over roughly 20,000 seats in most of the third deck and the outfield stands. The A's management said that the reason was to create a more intimate feeling for the fans. What's another explanation? The A's removed or put tarps over roughly 20,000 seats to
limit quantity to raise price.
Once the copyright runs out on a book or music, it can legally be placed on the Internet for anyone to download. However, the U.S. Congress recently extended the copyright law to 95 years after the original publication. But in Australia and Europe, the copyright holds for only 50 years. Thus, an Australian Web site could post Gone With the Wind, a 1936 novel, or Elvis Presley's 1954 single "That's All Right," while a U.S. site could not. Obviously, this legal nicety won't stop American fans from downloading from Australian or European sites. Discuss how limiting the length of a copyright would affect the pricing used by the publisher of a novel. What impact to pricing (before the copyright expires) will limiting copyright lengths have?
no change in prices because marginal cost will be unchanged.
A firm is a natural monopoly if
one firm can produce the total output of the market at lower cost than two or more firms could.
Why is the ratio of the monopoly's price to its marginal cost, pMC, smaller, the more elastic the demand curve at the optimum quantity? Can the demand curve be inelastic at that quantity? The ratio of the monopoly's price to its marginal cost, pMC, is smaller the more elastic the demand curve is at the optimum quantity because, as a function of ε, At the optimum quantity, the demand curve
p/MC=ε/1+ε cannot be inelastic because marginal revenue would be negative.
Grocery store chains often set consumer-specific prices by issuing frequent-buyer cards to willing customers and collecting information about their purchases. Grocery store chains use that data to offer customized discount coupons to individuals. Which type of price discrimination—perfect, group, or nonlinear—are these personalized discounts? Personalized grocery store discounts are a type of ______ price discrimination. A grocery store could increase profits by using past purchase data to charge lower prices to customers whose demand is relatively more ______
perfect elastic
If a monopoly faces an inverse demand curve of p=390−Q, has a constant marginal and average cost of $30, and can perfectly price discriminate, what is its profit? What are the consumer surplus, welfare, and deadweight loss? How would these results change if the firm were a single-price monopoly? Profit from single-price profit-maximization
profit= 64800 CS= 0 W=64800 DWL=0 profit= 32400 CS= 16200 W=48600 DWL=16200
Explain why charging a higher or lower price than p=20 (with a lump-sum fee equal to consumer surplus) reduces the monopoly's profit in the figure to the right. Show the monopoply's profit if p=60 and compare it to its profit if p=20 (with lump sum fees equal to the resulting consumer surplus using two-part tariffs and where marginal cost is m=20 per unit). Charging a price higher than p=20 reduces profit because Charging a price lower than p=20 reduces profit because
profitable units are not produced. unprofitable units are produced. profit from a two-part tariff when price is p=20 equals $4050 Profit from a two-part tariff when price is p=60 equals $3,250 (profit of new price plus area of CS)
If two identifiable markets differ with respect to their price elasticity of demand and resale is impossible, a firm with market power will
set a lower price in the market that is more price elastic.
Alexx's monopoly currently sells its product at a single price. What conditions must be met so that he can profitably price discriminate? The firm must have:
the ability to set price, consumers with different price elasticities, the ability to identify the different types of consumers, and the ability to prevent or limit resales.
Under what circumstances will a drug company charge more for its drug after it goes off patent? A drug company may charge more after it goes off patent if
the demand curve is less elastic at the new optimum.
If a monopoly chooses the optimal price instead of the optimal quantity, then its profits will be
unchanged because the optimal price and quantity yield the same profit.
If the inverse demand function a monopolyLOADING... faces is p(Q) and its cost function is C(Q), show the effect of a specific tax, τ, on the monopoly's profit-maximizing output. The monopoly's profit-maximizing output
will decline because the tax increases marginal cost to (ΔC(Q)/ΔQ)+τ The tax will decrease profit
The Challenge Solution explains that when generic drugs enter the market after the patent on a brand-name drug expires, the demand curve facing the brand-name firm shifts toward the origin (to the left). It also becomes less elastic at the original price (and becomes steeper). The firm now maximizes its profit at a point where the quantity is smaller. However, the new profit-maximizing price may be higher than the initial price because the demand curve is less elastic at the new optimum. Does the Challenge Solution change if the shift in the demand curve (that occurs due to the entry of the generic) is a parallel shift to the left (i.e. slope of the demand curve does not change). If entry produces a parallel shift left, then the brand-name firm
will not charge a higher price because its demand curve does not become steeper
Some people propose reducing the number of years that a drug patent lasts, but their critics argue that such a change would result in even higher prices during the patent period as companies would need to recover drug development costs more quickly. Is this argument valid if drug companies maximize profit? If patent lengths were reduced, then a monopoly drug manufacturer while under the patent
would not charge higher prices because demand would be unchanged.
Suppose there are two groups, a high-price group and a low-price group. Assume the monopoly has no fixed costs such that operating with a loss corresponds to operating where revenue is less than variable production costs. Also assume that if the monopoly sells to the low-price group, then it will incur losses. With the ability to group price discriminate, the monopoly
would not sell to the low-price group because it could just sell to the high price group and avoid losses.
If a monopoly faces an inverse demand curve of p=450−Q, has a constant marginal and average cost of $30, and can perfectly price discriminate, what is its profit? What are the consumer surplus, welfare, and deadweight loss? How would these results change if the firm were a single-price monopoly? Profit from perfect price discrimination (π) is Profit from single-price profit-maximization is π=
π=88,200 CS=0 W=88,200 DWL=0 π=$44,100 CS=22,050 W=66,150 DWL=22,050
Disneyland price discriminates by charging lower entry fees for children than adults and for local residents than for other visitors. Why does it not have a resale problem? Disney does not have a resale problem between adults and children (and between local residents and other visitors) because
children's tickets are color coded, and adults are hesitant to buy scalped tickets.
If the inverse demand function is p=50−0.5Q, what is the price elasticity of demand and revenue at Q=84 The price elasticity of demand is ε= Revenue (R) is R=
−0.190 (slope of d curve times p/q) $672 (pxq)
College students have a reservation price of $18 for movie tickets. Senior citizens have a reservation price of $14. If the price of a movie ticket is $14 or less, then 20 senior citizens will demand a ticket. However, no senior citizens will demand a ticket at prices above $14. If the price of a movie ticket is $18 or less, then 15 college students will demand a ticket. However, no college students will demand a ticket at prices above $18. Given the information in the table, if a movie theater does not price discriminate, then it charges either the highest price the college students are willing to pay or the one that the senior citizens are willing to pay. Why doesn't it charge an intermediate price? (Hint: Discuss how the demand curves of these two groups are unusual). The theater would practice price discrimination by charging college students $18 and senior citizens $14.
demand is not price sensitive in this price range.
Ticketmaster Corp. uses an Internet auction to sell tickets Is it engaging in price discrimination? If so, what type? Ticketmaster is engaging in
first−degree price discrimination.
The 2002 production run of 25,000 new Thunderbirds included only 2,000 cars for Canada. Yet potential buyers besieged Ford dealers there. Many buyers hoped to make a quick profit by reselling the cars in the United States. Reselling was relatively easy, and shipping costs were comparatively low. When the Thunderbird with the optional hardtop first became available at the end of 2001, Canadians paid C$56,550 for the vehicle, while U.S. customers spent up to C$73,000 in the United States. Why? Ford provided Canadian markets only 2,000 Thunderbirds in order to practice Why would a Canadian want to ship a T-Bird south? Absent transaction and transportation costs, a Canadian would buy a T-Bird in Canada and then sell it in the U.S. to Why did Ford require that Canadian dealers sign an agreement with Ford that prohibited moving vehicles to the United States? Ford required Canadian dealers to sign an agreement prohibiting moving vehicles south to the United States
group price discrimination. earn profit to prevent resale between Canada and the U.S.
Many colleges provide students from low-income families with scholarships, subsidized loans, and other programs so that they pay lower tuitions than students from high-income families. Explain why universities behave this way. Universities use scholarships, loans, and other programs to charge low-income students different prices (e.g., different tuition) than high-income students to increase profit with
group price discrimination
In the Challenge Solution, did the sales method achieve the same group price discrimination outcome that would be achieved if Heinz could set separate prices for loyal customers and for switchers? Why or why not? Part 2 Recall that in the Challenge Solution, Heinz charged the profit-maximizing price of $3.00 per bottle to loyal customers and $2.00 per bottle to switchers except every n days, when Heinz would run a sale, selling their ketchup for $2.00 per bottle to all customers. Otherwise, Heinz would sell their ketchup for $3.00 per bottle. Assume the marginal cost of production for Heinz is $1.00 per bottle, the marginal cost of generic ketchup is $2.01 per bottle, there are B loyal customers and S switching customers, each customer demands one bottle per day, and switchers are sensitive to sales and stock up on enough ketchup to last n days until it is on sale again but loyal customers are not and do not alter the timing of their shopping for ketchup sales. Thus, average profit per day for Heinz when using the sale scheme in the Challenge Solution is π*=2.00×Bn−1n+1.00×B1n+1.00×S.
higher because loyal customers would have always paid $3.00 per bottle of Heinz ketchup.
Describe the effects on output and welfare if the government regulates a monopoly so that it may not charge a price above p, which lies between the unregulated monopoly price and the optimally regulated price Compared to the outcome where social welfare is maximized, at the regulated outcome, the price is ________and the quantity the monopoly sells is______ In turn, compared to the socially-optimal outcome, with the regulated price, new ________ is created.
higher, lower dead weight loss
