Handout 14 Monopoly – Market Efficiency, and Price Discrimination This handout contains exercises of - Monopoly and Economic Efficiency - Price Discrimination Things you should know - What is the impact on economic efficiency when market power exists? - What are the required pre-conditions to price-discriminate? - How does a monopolist set prices and quantities if it can discriminate consumers – as firstand third-degree price discriminations? What is the impact on economic efficiency? Exercises Question 1 (Monopoly and Market Efficiency) Suppose the demand for a particular good is given by P = 120 – Q. This good is produced by a monopolist who has the cost function of TC = 0.5Q2 + 30Q + 100, and the marginal cost is given by MC = Q + 30. This monopolist cannot discriminate prices each consumer pays. 1. What would be the profit-maximizing behavior of this monopolist? What is its profit? 2. What are the price and quantity if this good were to be produced in a perfectly competitive setting? Compare the changes in consumer surpluses, producer surpluses, and, if any, deadweight losses in each case. Draw the graphs to illustrate these facts. 3. If this monopolist did not study Econ101 before starting his business and he decides to maximize the revenue instead. (This is usually seen in real life by managers who maximize sales instead of profits.) What would be the price and quantity if he does so? Compare the profits to the case where this monopolist maximizes his profits. Question 2 (Price Discrimination – Conceptual Question) Identify which kind of price discrimination is practiced in each of the following scenarios. i) Student price for Wisconsin Men’s Basketball tickets ii) Plastic molding company poisons material and labels “Not Suitable for Food Handling” iii) Priceline “Name Your Price” lets you choose the price you want for hotels and flights iv) Airlines and hotels charging different prices when buying at different time before travel Question 3 (First-Degree Price Discrimination) Suppose a hotel can perfectly identify how much each consumer is willing to pay and it knows that the demand curve is P = 100 – Q. The operating cost per room is constant at AC = MC = 20. 1. What is (are) the price(s) the hotel will charge to consumers? How many rooms would be sold? What is its profits? 2. What is the consumer surplus? What is the producer surplus? What is the deadweight loss? 3. Compare the results to the scenario where the hotel cannot price-discriminate and must charge a single price. Question 4 (Third-Degree Price Discrimination) Northeast Airlines has the same operating cost per passenger in First Class and Economy Class at MC = AC = 20. The demand by First Class passengers is P = 100 – 2Q, while the demand by Economy Class passengers is P = 50 – 0.5Q. 1. Suppose the airlines can price-discriminate, how many seats will the airlines sell? At what price(s)? What is its profits? 2. Suppose the airlines is unable to price-discriminate, how many seats will the airlines sell? At what price(s)? What is its profits? 1 Question 5 (Third-Degree Price Discrimination) 1. Kanit has to fly to Alaska tonight for important snowboard filming. Zander would maybe like to visit Alaska on vacation sometime next year. Both of them have not purchased airline tickets yet. Alaska Airlines is the only airliner that flies to Alaska and it has constant marginal cost that is greater than zero. Suppose Alaska Airlines can conduct third-degree price discrimination, it will charge ________ since ________ at the price charged. a. a higher price to Zander; he has higher price elasticity of demand b. a lower price to Zander; he has higher price elasticity of demand c. an equal price to both; they have equal price elasticity of demand d. a lower price to Kanit; he has lower price elasticity of demand One Year Season Pass 2015/2016 – STUDENT PRICING Mount Bohemia Ski Resort – the only premier ski resort in the Upper Peninsula Michigan Kanit Kuevibulvanich (University of Wisconsin-Madison) TERMS and CONDITIONS: ………………………………………………………………………. ………………………………………………………………………. ………………………………………………………………………. 2. Which of the following must be included in the Terms and Conditions of the Season Pass Ticket depicted above to enforce third-degree price discrimination? (Pick all applicable) i) This season pass may only be used by the person named above. ii) Student identification may be required to use this season pass. iii) Skiing and snowboarding are inherently dangerous activities. User assumes all risks. iv) Once purchased, this season pass is non-refundable. v) This season pass is not transferrable to another person. 2