Chapter 6

Question 1

Define marginal cost, marginal revenue and average cost

Answer 1

Marginal cost – additional cost of producing one additional unit
Marginal revenue – additional revenue of selling one additional unit
Average cost – total cost/units produced

Question 2

Define consumer surplus

Answer 2

– difference between total amount consumers are willing to pay for a good/service and what they actually pay

Question 3

No such thing as a correct price, but a best price under circumstances - some circumstances include:

Answer 3

• Profit maximisation
• Maximise welfare
• Survive price war
• Cover cost and provide benefit

Question 4

How is price set in perfect market and imperfect market conditions?

Answer 4

In perfect market prices set where MC=AC – competition sets price thus firms aim for profit maximisation
In imperfect competition – prices will not be at MC=AC; excessive profit or subsidisation may occur. Thus we can try achieve better tariffs through government regulation

Question 5

External influences when setting prices:

Answer 5

• Competition subsidised
• Firms with high proportion of common cost
• Large fluctuation in demand – peak load pricing

Question 6

To apply price discrimination 4 criteria must be met:

Answer 6

1. Sellers must have some monopolistic control – prices can’t be set by market
   a. Large demand, few suppliers – duopoly in airline routes
2. Sellers must divide market into sub-segments
   a. Business/economy
   b. Gender
3. Demand elasticity should differ in the markets – willingness to pay must differ
4. Product sold cannot be stored – production and consumption occur simultaneously
   If criteria are met – will be profitable in transport sector to price discriminate
   Typically occurs in decreasing average cost structure industry with high fixed costs and spare capacity.

Question 7

Explain how state company will set prices to maximise consumer welfare/discuss how SOE like railway company will set tariffs to maximise consumer welfare:

Answer 7

Notes

Question 8

There are various goals with price setting:

Answer 8

1. Revenue
2. Consumer behaviour
3. Economic efficiency – optimal allocation of resources – P=MC
   Prices theoretically set to marginal costs – consumer welfare maximised – not always possible

Question 9

Describe the typical tariff setting policy of a bus service given the nature of transport demand/discuss pricing policy of bus service for peak load pricing

Answer 9

Need to identify pattern of prices that:

1. ensures transport infrastructure used optimally
2. Guides future investment
3. Ensures all relevant costs covered

It is a problem of indivisibility in time and supply. Supply needs to match peak and off-peak demand. This is done via the price mechanism

Two demand period V1 (off-peak) and V2 (peak)
SMC=Supply curve
Where SMC meets V1 and V2 = output level and price level

Question 10

Must identify tariff (in peak load pricing) that:

Answer 10

Ensure transport infrastructure used optimally - not too much unused capacity too often
Provides guide to future investment policy - can cover future costs
Ensures all relevant costs are covered