Eco 201 Name_______________________________ Problem Set 13 7 December 2011 Cowen & Tabarrok, chapter 12 1. Serena is a single-price, profit-maximizing monopolist in the sale of her own patented perfume, whose demand and marginal cost curves are as shown. Relative to the consumer surplus that would result at the socially optimal quantity and price, how much consumer surplus is lost from her selling at the monopolist's profit-maximizing quantity and price? The profit-maximizing quantity is 8, the quantity for which MR=MC. The socially optimal quantity in this market is 12, the quantity for which MC = demand. The increase in consumer economic surplus that results when Q increases from 8 to 12 is the area of the blue-shaded trapezoid, or $100 per day. 2. True or False: A business that price discriminates will generally charge some customers more than marginal cost, and it will generally charge other customers less than marginal cost. No. Price discrimination has little to do with charging less than marginal cost. The goal is to charge some customers a little more than MC and others a lot more than MC. 3. If Congress passed a privacy law making it illegal for colleges to ask for parents’ tax returns, would that tend to help students from high-income families or students from low-income families? That would help students from high-income families. The price would settle down somewhere in between the “sticker price” and the “scholarship price,” so the rich families would get a price cut.4. Refer to the figure below that shows the market demand curves in two markets that are served by a firm. Using the principles of price discrimination, explain and calculate how much profit the firm could make. Figure: Monopoly Profits If the firm price discriminates, it will charge a price of $12 in Market 1 and $16 in Market 2 (which has the more inelastic demand curve). Profit in Market 1 = TR – TC TR = $12 × 200 = $2,400 TC = $8 × 200 = $1,600 Market 1 profit = $800 Profit in Market 2 = TR – TC TR = $16 × 200 = $3,200 TC = $8 × 200 = $1,600 Market 2 profit = $1,600 Total profit = $(800 + 1600) = $2,4005. A dry cleaner has a sign in its window: “Free internet coupons.” The dry cleaner lists its website, and indeed there are good discounts available with the coupons. Most customers don’t use the coupons. a. What probably would be the main difference between customers who use the coupons and those who don’t? Those who use the coupons are probably more price sensitive: They’re the kind of people who worry about saving a little on dry cleaning. (Those who use the coupons may also be poorer, on average, but that’s probably not as important as being price sensitive: Many poor people pay full price, and lots of non-poor people use coupons.) Overall message: The kind of people who can’t be bothered to carry around coupons probably have pretty inelastic demand for dry cleaning. b. Some people might think “The dry cleaner offers the coupons to get people in the door to try the place out, but then the customers will pay the normal high price afterward.” But the coupons are always there, so even repeat customers can keep using the coupons. Is this a mistake on the business owner’s part? Hint: Think about marginal cost. This chapter emphasized that as long as the product’s price is above the marginal cost of producing the product, it’s good to sell more. The coupon price is probably above marginal cost ( just like the drug price in Africa):The impulse shoppers pay the high price, and the careful shoppers pay the low price. As long as both prices are above marginal cost, this is a reasonable business decision. 6. Where are you more likely to see businesses “bundling” a lot goods into one package: In industries with high fixed costs and low marginal costs (like computer games or moviemaking), or in industries with low fixed costs and high marginal costs (like doctor visits, where the doctor’s time is expensive)? You tend to see bundling in low-marginal-cost industries, when the business has a big incentive to add a little bit more value to the product, since for little extra cost the business can charge a much higher