Economics 203: Intermediate Microeconomics I Lab Exercise #7 Price Discrimination

Section 1: Discussion: Some university bookstores give faculty a discount that students do not receive. Show with a sketch graph why this practice is most likely a profit-maximizing strategy instead of a college perk given to the faculty at college expense.

Section 2: Applications 1. The demand curve facing a monopolist is given by P = 350 7Q, and the short-run total cost curve is given by TC = 500 + 70Q, where TC is in $s and Q is in tonnes. What are the profit-maximizing price and quantity? Find the monopolist's economic profit. 2. A monopolist faces two separate demand curves: P1 = 65 2 Q1 and P2 = 35 3 Q2. The total cost curve is TC = 7 + 5Q. Find, P1, P2, Q1,and Q2. 3. Find the price elasticities of demand at equilibrium for Problem 2.

Solutions:

Section 1: Discussion: Some university bookstores give faculty a discount that students do not receive. Show with a sketch graph why this practice is most likely a profit-maximizing strategy instead of a college perk given to the faculty at college expense. Ans:
Price Student market Pf MR MR D D Price Faculty market Price

Ps

Horizontal sum of both markets MC GMR

Quantity
The graph shows a situation where the student demand is more inelastic at any price level than the faculty demand. (At any given price the location on the demand curve is proportionately further down the demand curve for the students.) For this reason, they can be charged a higher price. By observing where the MC is equal to the marginal revenue received from both markets, the bookstore manager will discover that overall profits are maximized when he charges Ps to the students and Pf to the faculty.

Section 2: Applications:
1. The demand curve facing a monopolist is given by P = 350 7Q, and the short-run total cost curve is given by TC = 500 + 70Q, where TC is in $s and Q is in tonnes. What are the profit-maximizing price and quantity? Find the monopolist's economic profit.
Marginal cost is equal to the slope of the straight line total cost curve: MC = 70. Marginal revenue has a slope which is twice as large as the slope of the demand curve: MR = 350 14Q. Set MC = 70 = 350 14Q = MR: Q = 280/14 = 20 tonnes. P = 350 7(20) = 350 140 = $210/tonne. Profit = PQ TC = 210(20) [500 + 70(20)] = 4200 1900 = $2300.

2. A monopolist faces two separate demand curves: P1 = 65 2 Q1 and P2 = 35 3 Q2. The total cost curve is TC = 7 + 5Q. Find, P1, P2, Q1,and Q2.

MC = slope of TC = 5 MR1 = 65 4 Q1 MR2 = 35 6 Q2 Set MR1 = MR2 = MC. First solve for Q1 and P1: 65 4 Q1 = 5 4 Q1 = 60 Q1 = 60/4 = 15 kg. P1 = 65 2(15) = $35/kg. Next solve for Q2 and P2: 35 6 Q2 = 5 6 Q2 = 30 Q2 =30/6 = 5 kg. P2 = 35 3(5) = $20/kg.

3. Find the price elasticities of demand at equilibrium for Problem 2.

Elasticity l = (Q1/P1)(P1/Q1) = (1/2)(35/15) = 7/6. Elasticity 2 = (1/3)(20/5) = 4/3. Check: MR= P(1 + 1/) MR1 = 35(1 6/7) = 5 MR2 = 20(1 3/4) = 5

Lab Quiz solutions: 1. With second-degree price discrimination, one would expect that A) people who buy a lot pay a lower price. B) people who buy relatively little pay a lower price. C) the monopolist cannot earn economic profits. D) producer surplus is lower than under single-price monopoly. E) more than one of the above is true. Ans: A 2. Which of the following could involve price discrimination? A) the issuing of discount theatre tickets B) airline offers of super-saver fares C) department store sales. D) all of the above could be caused by price discrimination. E) not all of the above could be caused by price discrimination Ans: D 3. For a profit-maximizing monopolist selling in two separate markets, it is necessarily true that A) MC = MR in both markets. B) the market with the less elastic demand contributes more to total profits. C) the price is higher in the market with the more elastic demand. D) the monopolist sells a larger quantity in the market with the more elastic demand. E) A and B are true. Ans: A 4. Price discrimination is possible only if A) economies of scale exist. B) the market can be segmented into discrete submarkets. C) each person in the market has the same elasticity of demand. D) prices are kept secret so those paying the high price do not know that others paid less. Ans: B 5. Which of the following explains why theatre prices for popcorn are three or four times higher than the popcorn price in grocery stores? A) Grocery stores sell a much higher volume and get their profits that way. B) The cost of popping theatre popcorn is high. C) Grocery stores are satisfied with normal profit, while theatres seek economic profit. D) The demand curve for popcorn in theatres is far more inelastic over the relevant price range than the demand for popcorn at grocery stores. E) None of the above is a reasonable explanation of the price differences. Ans: D

Name:____________________ Student #:_________________ Lab Section:________________ Lab #7 Quiz Question 1. With second-degree price discrimination, one would expect that A) people who buy a lot pay a lower price. B) people who buy relatively little pay a lower price. C) the monopolist cannot earn economic profits. D) producer surplus is lower than under single-price monopoly. E) more than one of the above is true. 2. Which of the following could involve price discrimination? A) the issuing of discount theatre tickets B) airline offers of super-saver fares C) department store sales. D) all of the above could be caused by price discrimination. E) not all of the above could be caused by price discrimination 3. For a profit-maximizing monopolist selling in two separate markets, it is necessarily true that A) MC = MR in both markets. B) the market with the less elastic demand contributes more to total profits. C) the price is higher in the market with the more elastic demand. D) the monopolist sells a larger quantity in the market with the more elastic demand. E) A and B are true. 4. Price discrimination is possible only if A) economies of scale exist. B) the market can be segmented into discrete submarkets. C) each person in the market has the same elasticity of demand. D) prices are kept secret so those paying the high price do not know that others paid less. 5. Which of the following explains why theatre prices for popcorn are three or four times higher than the popcorn price in grocery stores? A) Grocery stores sell a much higher volume and get their profits that way. B) The cost of popping theatre popcorn is high. C) Grocery stores are satisfied with normal profit, while theatres seek economic profit. D) The demand curve for popcorn in theatres is far more inelastic over the relevant price range than the demand for popcorn at grocery stores. E) None of the above is a reasonable explanation of the price differences.