CHAPTER 11 - CHAPTER 11 PRICING WITH MARKET POWER REVIEW QUESTIONS 1 Suppose a firm can practice perfect first-degree price discrimination What is

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CHAPTER 11 PRICING WITH MARKET POWER REVIEW QUESTIONS 1. Suppose a firm can practice perfect, first-degree price discrimination. What is the lowest price it will charge, and what will its total output be? When the firm is able to practice perfect first-degree price discrimination, each unit is sold at the reservation price of each consumer, assuming each consumer purchases one unit. Because each unit is sold at the consumer’s reservation price, marginal revenue is simply the price of the last unit. We know that firms maximize profits by producing an output such that marginal revenue is equal to marginal cost. For the perfect price discriminator, that point is where the marginal cost curve intersects the demand curve. Increasing output beyond that point would imply that MR < MC , and the firm would lose money on each unit sold. For lower quantities, MR > MC , and the firm should increase its output. 2. How does a car salesperson practice price discrimination? How does the ability to discriminate correctly affect his or her earnings? The relevant range of the demand curve facing the car salesperson is bounded above by the manufacturer’s suggested retail price plus the dealer’s markup and bounded below by the dealer’s price plus administrative and inventory overhead. By sizing up the customer, the salesperson determines the customer’s reservation price. Through a process of bargaining, a sales price is determined. If the salesperson has misjudged the reservation price of the customer, either the sale is lost because the customer’s reservation price is lower than the salesperson’s guess or profit is lost because the customer’s reservation price is higher than the salesperson’s guess. Thus, the salesperson’s commission is positively correlated to his or her ability to determine the reservation price of each customer. 3. Electric utilities often practice second-degree price discrimination. Why might this improve consumer welfare? Consumer surplus is higher under block pricing than under monopoly pricing because more output is produced. For example, assume there are two prices P 1 and P 2 , with P 1 greater than P 2 . Customers with reservation prices above P 1 pay P 1 , capturing surplus equal to the area bounded by the demand curve and P 1 . This also would occur with monopoly pricing. Under block pricing, customers with reservation prices between P 1 and P 2 capture surplus equal to the area bounded by the demand curve, the difference between P 1 and P 2 , and the difference between Q 1 and Q 2 . This quantity is greater than the surplus captured under monopoly, hence block pricing, under these assumptions, improves consumer welfare. Figure 11.3 4. Give some examples of third-degree price discrimination. Can third-degree price discrimination be effective if the different groups of consumers have different levels of demand but the same price elasticities? To engage in third-degree price discrimination, the producer must separate customers into distinct markets (sorting) and
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This note was uploaded on 12/04/2010 for the course BUAD 38384 taught by Professor Franklin during the Spring '10 term at Alabama.

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CHAPTER 11 - CHAPTER 11 PRICING WITH MARKET POWER REVIEW QUESTIONS 1 Suppose a firm can practice perfect first-degree price discrimination What is

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