Problem #5, Chapter 9•Explain why price discrimination and the existence of slightly different variants of the same product tend to go hand in hand. Give an example from your own experience.
Solution to Problem #5 (1) • To capture a higher profit for itself, a monopoly produces less than the perfectly competitively output • If it is legal, a monopoly will set a number of prices for a number of slightly differentiated products • A monopoly can earn a higher profit by setting a pricing strategy that is able to identify different types of customer • This pricing strategy requires so much information, particularly the distinctive characteristics and reservation price of the customers
Solution to Problem #5 (2) • When customers’ reservation prices are identified, a monopoly can then produce products that are slightly different from each other • The differentiation should reveal the distinctive characteristics of the types of customer so that customers can self-select to the differentiated products • As a result, price discrimination and existence of slightly different variants of the same product always come hand in hand
Solution to Problem #5 (3) • Example • Automobile •A typical automobile often comes in three options available to choose from •The options are very similar to each other, but they are sold in three level of prices•The cheapest option- a basic vehicle with manual transmission and no stereo system and air conditioner•The moderate option- a basic vehicle with auto transmission, stereo system, air conditioner and other automotive features, such as power seats and power locks
Solution to Problem #5 (4) • The most expensive option- a basic vehicle with all the features available on the moderate option plus some luxurious touches like sunroof and leather seats • Low-income drivers tend to choose the cheapest option • Average-income drivers tend to choose the moderate option • High-income drivers tend to choose the most expensive option • The monopoly is thus able to earning a profit by serving three types of customer with a differentiated product
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