Term 1 week 7

Question 1

What is price discrimination and what is it based on?

Answer 1

A firm engages in price discrimination by charging consumers different prices for the same good based on:
-Individual characteristics
-Belonging to an identifiable group of -consumers
-The quantity purchased

Question 2

Why does a firm earn higher profit from price discrimination compared to uniform pricing?

Answer 2

-PD firms charge higher prices to those who are willing to pay more
-PD firms sell to some people who are not willing to pay the uniform price.

Compensate lower MWTP for higher MWTP

Question 3

What are the necessary conditions for price discrimination?

Answer 3

1. A firm must have market power (otherwise it cannot charge over competitive price)
2. A firm must identify which consumers are willing to pay relatively more and there must be a maximum someone is able to pay.
3. A firm must prevent resale from those who payed a relatively lower price to those who are charged a higher price.

Question 4

Is all differential pricing price discrmination?

Answer 4

No, as sometimes it may just be reflecting costs eg news stand magazine more expensive than direct mailing.

Question 5

What is the inverse demand curve?
Label each part

Answer 5

P = a - Q

P= price
a = constant part of demand
Q = quantity

Question 6

What does the constant part of demand?

Answer 6

• The level of demand for a good if it was free

Question 7

What is the total cost of production for a monopolist?

Answer 7

C(Q)

Question 8

What is the profit function for a monopolist?

Answer 8

C(a-Q) - C(Q)

Question 9

What are the types of price discrimination?

Answer 9

First degree
Second degree
Third degree

Question 10

What is first price discrimination?

Answer 10

Each unit is sold at consumers reservation price so all consumer surplus is eroded. (Extracts all consumer surplus).

Question 11

What is second price discrimination?

What are examples of it?

Answer 11

AKA Non-linear price discrimination.
The monopolist has incomplete information.

-They know consumers have different tastes but cannot tell them apart before purchase.

-Hence self selection designs are used to set the correct price-quantity package.

Quantity discounts

Question 12

What is the basis of price discrimination?

Answer 12

The monopolist can charge some people a price that is higher than its MC.

Question 13

Why is price discrimination used?

Answer 13

When a firm wants to sell an extra unit there are two effects:
There is an increase in revenue due to extra sale
There is a decrease in revenue due to the fall in price of existing units.

Price discrimination is an effort to decrease the second impact by expanding sales.

Question 14

What is third degree price discrimination?

Answer 14

You can identify different groups and identify their demand functions.

You know there are different groups and can identify them.

And know that charging the same amount across the two groups is not profitable.

Question 15

Graphically in perfect competition what is 1st degree price discrimination?

Answer 15

MC and demand intersect.

Usually the two triangles are producer and consumer surplus but the consumer surplus is removed all by the producer.

Question 16

Draw a diagram showing the consumer and producer surplus of a monopolist.

What happens graphically compared to a monopolist in imperfect competition?

Answer 16

-

-Everything becomes producer surplus and there is no deadweight loss under first degree price discrimination.

-The outcome is efficient as all there is no deadweight loss

-But outcome is harmful to consumers as all welfare is producer surplus.

Question 17

What is an example of third degree price discrimination

Answer 17

10% student discount

can identify different groups and charge them different for same good.

Question 18

What is the difference between a demand curve and an inverse demand curve?

Answer 18

Demand curve has Q as subject
Inverse demand curve rearrange for P as subject.

Question 19

What is the demand curve the same as?

Answer 19

Same as average revenue curve for monoplist.

Question 20

How do you get marginal revenue curve for monopolist?

Answer 20

You get total revenue curve and then take derivative.

Question 21

What is the model for 3rd degree price discrimination?

Answer 21

-Consumers can be divided into two groups

-Monopolist knows demand curve of each group

-cost function of monopolist is given by c(Q) where Q = Q1 + Q2

-Monopolist can charge different prices to each group.

-Then create profit of the monopolists

pi = p1(Q1)Q1 + p2(Q2)Q2 - C(Q)

F.O.C

p1(Q1) + p1’(Q1) . Q1 = C’(Q)
p2(Q2) + p2’(Q2) . Q2 = C’(Q)

This shows that first market
Mr1 = MC
Mr2 = MC
So Mr1 = Mr2 = MC

Then re-write the MR with p1(Q1) at the front
Then sub in the definition of elasticity so it becomes
p1I(Q1) (1-1/e) = p2(Q2)(1-1/e)

Question 22

What is important to remember when we do the 3rd degree price discrimination problem F.O.C

Answer 22

USE CHAIN RULE!

Question 23

What does the third degree price discrimination model imply?

Answer 23

p1(1-1/e1) = p2(1-1/e2)
The monopolist chargest a lower price in the market that is more elastic.

This is because if e1> e2 in order for equality to hold price has to ddrop in market 1.

Question 24

With diagrams how can you show 3rd degree price discriination

Answer 24

First draw the elastic market with MR and AR which have less steep curves
(lower price)

Then side by side draw the inelastic market with the higher price and the more steep demand curves.

Question 25

What is a piece wise aggregate demand function and how do you create them?

Answer 25

You look at the bounary of the high demand market
Look at the boundary of the low demand market and then find when one market would serve and when both would serve.

Question 26

How do you draw all three diagrams when doing third degree price discrimination

Answer 26

Draw high demand market
Draw low demand market
Draw both markets in one.

The intercepts are calculated using the piecewise functions.

Question 27

What is the piecewise agregate demand

Answer 27

Using the piecewise agregate demand functions you use the previously found boundaries and then but in the quantity and sub it in to find the next boundaries.

Question 28

How do you find the MR piecewise demand.

Answer 28

The same as inverse demand piece wise boundaries just change the functions by taking derivative of TR.

Question 29

When would a monopoly not choose to be a single price monopolist?

Answer 29

Example, when market demand for one is so low that MC does not intercept MR so then it would have to charge a lower price for all the high demand units so it does not cater to that market at all.

Makes it unprofitable to cater to both markets.

It will have a loss in revenue.

Question 30

For a kinked demand curve what happens with MR curve?

Answer 30

The MR curve also has to be kinked and check where the MR curve starts

Question 31

How do you choose whether a monopoly should price discriminate or just cater to one market?

Answer 31

You work out the profits under PD
and then work out the profits with a single price and see what is higher.