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Microeconomics

Robert S. Pindyck, Daniel L. Rubinfeld

Chapter 11

Pricing with Market Power - all with Video Answers

Educators

Chapter Questions

04:42

Problem 1

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and arbitrage:
a. Requiring airline travelers to spend at least one Saturday night away from home to qualify for a low fare.
b. Insisting on delivering cement to buyers and basing prices on buyers' locations.
c. Selling food processors along with coupons that can be sent to the manufacturer for a $\$ 10$ rebate.
d. Offering temporary price cuts on bathroom tissue.
e. Charging high-income patients more than lowincome patients for plastic surgery.

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator
03:50

Problem 2

If the demand for drive-in movies is more elastic for couples than for single individuals, it will be optimal for theaters to charge one admission fee for the driver of the car and an extra fee for passengers. True or false? Explain.

Karan Sood
Karan Sood
Numerade Educator
06:56

Problem 3

In Example 11.1 (page 416 ), we saw how producers of processed foods and related consumer goods use coupons as a means of price discrimination. Although coupons are widely used in the United States, that is not the case in other countries. In Germany, coupons are illegal.
a. Does prohibiting the use of coupons in Germany make German consumers better off or worse off?
b. Does prohibiting the use of coupons make German producers better off or worse off?

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator
03:32

Problem 4

Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to $\$ 20,000$ and a fixed cost of $\$ 10$ billion. You are asked to advise the CEO as to what prices and quantities BMW should set for sales in Europe and in the United States, The demand for BMWs in each market is given by
$$Q_{E}=4,000,000-100 P_{E}$$ and $$Q_{u}=1,000,000-20 P_{\mathrm{U}}$$
where the subscript $E$ denotes Europe, the subscript
$u$ denotes the United States. Assume that BMW can restrict U.S. sales to authorized BMW dealers only.
a. What quantity of BMWs should the firm sell in each market, and what should the price be in each market? What should the total profit be?
b. If $\mathrm{BMW}$ were forced to charge the same price in each market, what would be the quantity sold in each market, the equilibrium price, and the company's profit?

Heather Zimmers
Heather Zimmers
Numerade Educator

Problem 5

A monopolist is deciding how to allocate output between two geographically separated markets (East Coast and Midwest), Demand and marginal revenue for the two markets are $$\begin{array}{ll}P_{1}=15-Q_{1} & \mathrm{MR}_{1}=15-2 Q_{1} \\
P_{2}=25-2 Q_{2} & \mathrm{MR}_{2}=25-4 Q_{2}\end{array}$$ The monopolist's total cost is $C=5+3\left(Q_{1}+Q_{2}\right)$ What are price, output, profits, marginal revenues, and deadweight loss (i) if the monopolist can price discriminate?
(ii) if the law prohibits charging different prices in the two regions?

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13:02

Problem 6

Elizabeth Airlines (EA) flies only one route: ChicagoHonolulu. The demand for each flight is $Q=500-P$ EA's cost of running each flight is $\$ 30,000$ plus $\$ 100$ per passenger.
a. What is the profit-maximizing price that EA will charge? How many people will be on each flight? What is EA's profit for each flight?
b. EA learns that the fixed costs per flight are in fact $\$ 41,000$ instead of $\$ 30,000 .$ Will the airline stay in business for long? Illustrate your answer using a graph of the demand curve that EA faces, EA's average cost curve when fixed costs are $\$ 30,000,$ and EA's average cost curve when fixed costs are $\$ 41,000$
c. Wait! EA finds out that two different types of people fly to Honolulu. Type $A$ consists of business people with a demand of $Q_{\lambda}=260-0.4 P$. Type $B$ consists of students whose total demand is $Q_{\mathrm{B}}=240-0.6 P$ Because the students are easy to spot, EA decides to charge them different prices. Graph each of these demand curves and their horizontal sum. What price does EA charge the students? What price does it charge other customers? How many of each type are on each flight?
d. What would EA's profit be for each flight? Would the airline stay in business? Calculate the consumer surplus of each consumer group. What is the total consumer surplus?
e. Before EA started price discriminating, how much consumer surplus was the Type $A$ demand getting from air travel to Honolulu? Type $B$ ? Why did total consumer surplus decline with price discrimination, even though total quantity sold remained unchanged?

Lindsay Bur
Lindsay Bur
Numerade Educator
02:01

Problem 7

Many retail video stores offer two alternative plans for renting films:
A two-part tariff: Pay an annual membership fee (e.g., $\$ 40$ ) and then pay a small fee for the daily rental of each film (e.g., $\$ 2$ per film per day).
A straight rental fee: Pay no membership fee, but pay a higher daily rental fee (e.g., \$4 per film per day).
What is the logic behind the two-part tariff in this case? Why offer the customer a choice of two plans rather than simply a two-part tariff?

Breanna Ollech
Breanna Ollech
Numerade Educator
09:26

Problem 8

Sal's satellite company broadcasts TV to subscribers in Los Angeles and New York. The demand functions for each of these two groups are $$C=1000+40 Q$$
where $Q=Q_{s x}+Q_{1}$
a. What are the profit-maximizing prices and quantities for the New York and Los Angeles markets?
b. As a consequence of a new satellite that the Pentagon recently deployed, people in Los Angeles receive Sal's New York broadcasts and people in New York receive Sal's Los Angeles broadcasts. As a result, anyone in New York or Los Angeles can receive Sal's broadcasts by subscribing in either city. Thus Sal can charge only a single price. What price should he charge, and what quantities will he sell in New York and Los Angeles?
c. In which of the above situations, (a) or (b), is Sal better off? In terms of consumer surplus, which situation do people in New York prefer and which do people in Los Angeles prefer? Why?

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator
04:19

Problem 9

You are an executive for Super Computer, Inc. (SC), which rents out super computers. SC receives a fixed rental payment per time period in exchange for the right to unlimited computing at a rate of $P$ cents per second. SC has two types of potential customers of equal number-10 businesses and 10 academic institutions. Each business customer has the demand function $Q=10-P,$ where $Q$ is in millions of seconds per month; each academic institution has the demand $Q=8-P$. The marginal cost to $\mathrm{SC}$ of additional computing is 2 cents per second, regardless of volume.
a. Suppose that you could separate business and academic customers. What rental fee and usage fee would you charge each group? What would be your profits?
b. Suppose you were unable to keep the two types of customers separate and charged a zero rental fee. What usage fee would maximize your profits? What would be your profits?
c. Suppose you set up one two-part tariff-that is, you set one rental and one usage fee that both business and academic customers pay. What usage and rental fees would you set? What would be your profits? Explain why price would not be equal to marginal cost.

James Kiss
James Kiss
Numerade Educator
02:53

Problem 10

As the owner of the only tennis club in an isolated wealthy community, you must decide on membership dues and fees for court time, There are two types of tennis players. "Serious" players have demand $$Q_{1}=10-P$$ where $Q_{1}$ is court hours per week and $P$ is the fee per hour for each individual player. There are also "occasional" players with demand $$Q_{2}=4-0.25 P$$ Assume that there are 1000 players of each type. Because you have plenty of courts, the marginal cost of court time is zero. You have fixed costs of $\$ 10,000$ per week. Serious and occasional players look alike, so you must charge them the same prices. a. Suppose that to maintain a "professional" atmosphere, you want to limit membership to serious players. How should you set the anmul membership dues and court fees (assume 52 weeks per year) to maximize profits, keeping in mind the constraint that only serious players choose to join? What would profits be (per week)?
b. A friend tells you that you could make greater profits by encouraging both types of players to join. Is your friend right? What annual dues and court fees would maximize weekly profits? What would these profits be?
c. Suppose that over the years, young, upwardly mobile professionals move to your community, all of whom are serious players. You believe there are now 3000 serious players and 1000 occasional players. Would it still be profitable to cater to the occasional player? What would be the profitmaximizing annual dues and court fees? What would profits be per week?

Prashant Bana
Prashant Bana
Numerade Educator
00:53

Problem 11

Look again at Figure $11.12(\mathrm{p} .428),$ which shows the reservation prices of three consumers for two goods. Assuming that marginal production cost is zero for both goods, can the producer make the most money by selling the goods separately, by using pure bundling, or by using mixed bundling? What prices should be charged?

Marcus Esteban
Marcus Esteban
Numerade Educator
08:00

Problem 12

Look again at Figure 11.17 (p. 432 ). Suppose that the marginal costs $c_{1}$ and $c_{2}$ were zero. Show that in this case, pure bundling, not mixed bundling, is the most profitable pricing strategy. What price should be charged for the bundle? What will the firm's profit be?

Matthew Smith
Matthew Smith
Numerade Educator
02:53

Problem 13

Some years ago, an article appeared in the New York Times about IBM's pricing policy. The previous day, IBM had announced major price cuts on most of its small and medium-sized computers. The article said:
IBM probably has no choice but to cut prices periodically to get its customers to purchase more and lease less. If they succeed, this could make life more difficult for IBM's major competitors. Outright purchases of computers are needed for ever larger IBM revenues and profits, says Morgan Stanley's Ulric Weil in his new book, Information Systems in the $80^{\circ}$ s. Mr. Weil declares that IBM cannot revert to an emphasis on leasing.
a. Provide a brief but clear argument in support of the claim that IBM should try "to get its customers to purchase more and lease less."
b. Provide a brief but clear argument against this claim.
c. What factors determine whether leasing or selling is preferable for a company like IBM? Explain briefly.

EA
Erwin Antoni
Numerade Educator
03:11

Problem 14

You are selling two goods, 1 and 2 , to a market consisting of three consumers with reservation prices as follows: The unit cost of each product is $\$ 30$
a. Compute the optimal prices and profits for (i) selling the goods separately, (ii) pure bundling, and
(iii) mixed bundling.
b. Which strategy would be most profitable? Why?

Michael Nartey
Michael Nartey
Numerade Educator
00:53

Problem 15

Your firm produces two products, the demands for which are independent. Both products are produced at zero marginal cost. You face four consumers (or groups of consumers) with the following reservation prices: a. Consider three alternative pricing strategies:
(i) selling the goods separately; (ii) pure bundling;
(iii) mixed bundling. For each strategy, determine the optimal prices to be charged and the resulting profits. Which strategy would be best? b. Now suppose that the production of each good entails a marginal cost of $\$ 30 .$ How does this information change your answers to (a)? Why is the optimal strategy now different?

Marcus Esteban
Marcus Esteban
Numerade Educator
13:02

Problem 16

A cable TV company offers, in addition to its basic service, two products: a Sports Channel (Product 1) and a Movie Channel (Product 2). Subscribers to the basic service can subscribe to these additional services individually at the monthly prices $P_{1}$ and $P_{2}$ respectively, or they can buy the two as a bundle for the price $P_{8^{\prime}}$ where $P_{\mathrm{B}}<P_{1}+P_{2^{*}}$ They can also forgo the additional services and simply buy the basic service. The company's marginal cost for these additional services is zero. Through market research, the cable company has estimated the reservation prices for these two services for a representative group of consumers in the company's service area. These reservation prices are plotted (as $x$ 's) in Figure 11.21 , as are the prices $P_{1}$
$P_{2}$ and $P_{B}$ that the cable company is currently charging. The graph is divided into regions $\mathrm{I}, \mathrm{II}, \mathrm{III},$ and $\mathrm{IV}$. a. Which products, if any, will be purchased by the consumers in region I? In region II? In region III? In region IV? Explain briefly.
b. Note that as drawn in the figure, the reservation prices for the Sports Channel and the Movie Channel are negatively correlated. Why would you, or why would you not, expect consumers' reservation prices for cable TV channels to be negatively correlated?
c. The company's vice president has said: "Because the marginal cost of providing an additional channel is zero, mixed bundling offers no advantage over pure bundling. Our profits would be just as high if we offered the Sports Channel and the Movie Channel together as a bundle, and only as a bundle." Do you agree or disagree? Explain why.
d. Suppose the cable company continues to use mixed bundling to sell these two services. Based on the distribution of reservation prices shown in Figure 11.21 do you think the cable company should alter any of the prices that it is now charging? If so, how?

Lindsay Bur
Lindsay Bur
Numerade Educator
02:11

Problem 17

Consider a firm with monopoly power that faces the demand curve and has the total cost function
$$C=4 Q^{2}+10 Q+A$$ where $A$ is the level of advertising expenditures, and $P$ and $Q$ are price and output.
a. Find the values of $A, Q,$ and $P$ that maximize the firm's profit.
b. Calculate the Lerner index, $L=(P-M C) / P$, for this firm at its profit-maximizing levels of $A, Q,$ and $P$

Yang Su
Yang Su
Numerade Educator