Chapter 9 explain why price discrimination and the

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