Price discrimination

A producer of cement has a monopoly of the market in the area adjoining his plant, but is an insignificant factor in the rest of the country, where there are many competing producers. He can sell any desired portion of his output in the competitive market at the price there prevailing. Given the price prevailing in the competitive market, the demand schedule in his own monopolized market, his own average cost schedule, and any additional information which may be necessary for the solution of the problem, find the price he should charge in his own market, and the quantities he should sell in each market, to maximize his net revenue.

(Answer both parts)

A. Defined or very briefly describe:

(1) Inelastic demand

(2) Elastic demand

(3) Incremental (or marginal) revenue

(4) Perfect competition (in terms of demand elasticity)

(5) Pure profit

(6) Productivity (incremental or marginal of a particular agency or factor)

B. Is export dumping evidence of domestic monopoly? Explain. Under what conditions does export dumping lead to a lower domestic price in the exporting country?

For each of the following methods of financing radio and television programs, indicate how the resulting structure of programs differs from the optimum: and under what conditions, if any, it would be an optimum. In interpreting “optimum”, assume that the only consideration is direct private benefit from the programs; neglect distributional effects, i.e., treat it as a purely allocative problem; and assume that there are no such public issues involved as “education” or “indoctrination”. On the technical side, assume throughout that there are a narrowly limited total number of frequencies or channels available in any one area. Make your answer as definite as possible in terms of the kind of people whose tastes are or are not catered to appropriately, the kinds of programs that are too numerous or too sparse, etc. In answering the question, assume throughout that it is possible without cost to know exactly the number and kind of people who listen to each program.

The existing U.S. method of selling time to advertisers.

Imposition of an annual license tax or fee on each set; auctioning off of time to private program producers; compensation of these producers by giving to each a share of the total tax collection equal to the fraction of total listener time devoted to his programs. Assume that advertising is forbidden.

Some mechanical method whereby a subscriber can receive a particular program only if he pays through a coin-box arrangement for that particular program. The programs are to be provided by private producers who receive the payments, who buy time on the stations, as in the preceding case, and who can determine the amount charged for the programs they produce. Once again, assume that advertising is forbidden.

Fair trade is now rapidly disappearing. However, a few firms (Sunbeam, Schaeffer) are actively trying to enforce fair trade pricing.

(a) Are these firms just misguided or are there circumstances in which fair trade would help them?

(b) If fair trade were generally observed, what would be the effect on return on capital and entrepreneurial effort engaged in retailing?

A recent court decree requires a company (The United Shoe Machinery Co.) which heretofore has only leased its machines, for which there are at present no competitors, to offer them for sale at prices which will make it neither more nor less advantageous to buy than to rent the machines. How can such prices be determined, and by what criteria can it be determined whether a given price meets the requirement?

I. Indicate whether each of the following statements is true (T), false (F), or uncertain (U) and state briefly (on this paper) the reason for your answer.

The elasticity of a straight line demand curve varies from point to point.

In the long run, demand has no influence on the price of the product of a competitive industry that uses no specialized resources.

Marginal revenue is always greater than average revenue when average revenue is rising as quantity increases.

[4. and 5.] Assume that the government is going to purchase a predetermined quantity of rice for foreign relief and that it is considering making its purchases (a) directly from the growers of rice, or (b) through the regular dealer on the grain exchange. Assume also that there are no other governmental actions affecting rise growing or marketing.

The price to the domestic consumer of rice that remains will be higher in case (a) than in case (b).

The price received by the farmer for the rice that remains will be higher in case (a) than in case (b).

An “inferior” good is one such that a larger quantity is demanded at a high than at a low price.

If the quantity of Y increases and the quantity of X decreases in such a way as to keep total utility constant, then the rate of substitution of Y for X is independent of the quantity of X.

The income of the farmers raising corn increases when the price of corn rises. The rise in income is the “income effect of the rise in price.”

[9., 10., 11.] The Gimcrack Company is a monopoly, selling in two distinct markets. Transportation costs between the two markets can be neglected.

The company will always charge the same price for gimcracks in the two markets.

The company will sell such quantities in the two markets as will make the elasticities of demand the same in the two markets.

The company will sell such quantities in the two markets as will make marginal revenue the same in the two markets.

The current charge for telephone service in city C is $6.40 per month, allowing the consumer 80 free local calls every month, Each additional call costs five cents. Installation is free, and no long-distance calls are available.

NOTE: In the following, assume that each consumer behaves rationally, has constant money income and tastes, with convex indifference curves and no saturation in the relevant range.

Use separate diagrams for each sub-problem. Be precise.

Use a diagram with money-income Y and phone calls X on the axes, to show a consumer’s budget constraint. Be careful to show all the combinations of X and Y available to him, including the case where no service is installed.

(This portion is crucial for the rest of the problem).

Use indifference curves between Y and X to analyze the consumer’s decision whether to have a telephone installed or not.

Consumer A chooses to have a telephone, and he uses 120 calls every month. Show his equilibrium position geometrically. What is the average price (in cents) of a phone call for him? What is his marginal rate of substitution between money and phone calls?

If the current rates are replaced by a flat rate of 7 cents a call for any number of calls,

(a) Show consumer A’s new budget line, compared with the current position.

(b) Would he now use more or less than 120 calls per month?

(c) Would he be better-off, indifferent, or worse-off relative to the current position?

Consumer A claims that he would prefer to pay a flat rate of 84 per call rather than the current rates. Could he be rational? (demonstrate your answer geometrically).

Consumer B uses only the 80 “free” calls every month, given the current rates. Compare (as in (4)) his consumption and welfare positions with the alternative of being charged a flat rate of 8¢ per call for any number of calls. Could he be indifferent with respect to the two alternative rates?

A recent survey found that supermarkets in low income areas charge higher average prices than supermarkets in high income areas for many identical items. This is consistent with

(a) price discrimination in the sale of groceries

(b) no price discrimination

(c) lack of competition in the retail grocery market

(d) competition in the retail grocery market.

Check those that apply.

In the 1880’s there were a class of independent railroad ticket brokers called “scalpers,” who purchased tickets in quantity at reduced prices from the railroads and resold them to the public, typically at prices below the prices posted by the railroads and charged to people who bought tickets at the railroad windows.

In discussing the practice in its 1890 report, the Interstate Commerce Commission argues that (a) it raised the cost of transportation because it made it necessary, “to support the auxiliary force of scalpers,” and (b) also reflected “the avidity of nearly every railroad to do a greater amount of passenger business than any competitor.”

Is (a) correct? Is it consistent with (b)?

Currently, the number of taxicabs permitted to operate in the city of Chicago is limited by licensure, no new licenses are being issued, and existing licenses which can be transferred sell for substantial sums. In addition, the price which taxicabs charge is fixed by the city. (A) Suppose restrictions on licensure were lifted but prices continued to be fixed at present levels. What would be the effect on (a) number of cabs, (b) incomes of non-driving owners of cabs, (c) wages of non-owning (i.e., hired) cab drivers?

(B) Suppose the price restrictions were lifted, so cabs could charge whatever they wanted. What would you expect to happen to prices for taxicab rides, both with respect to level and structure?

A power monopoly, operating within the range where there are net internal economies of large-scale production sells current for both industrial and domestic use. The distribution costs on the latter are 20 cents per unit higher than for the former. Given: (a) the industrial demand schedule for current; (b) the domestic demand schedule for current; (c) the average cost schedule for generating current plus distributing it to industrial users.

What rates should be charged to each type of customer to maximize the net income of the company?

Almost all railroads are reported to have gross revenues from dining car service that are less than the direct expenses of providing the service. In their own interest the railroads should increase the price of dining car meals.

(15 points) The University City Art Theater, a motion picture house showing foreign films, has the following price policies: The basic admission price is $1.00 for evening performances and 60 cents in the afternoon. Registered university students are admitted at half price at all times. A member of the University’s economics department has complained that the theater is a discriminating monopolist and should be required by local ordinance to follow a one-price policy. Comment on the desirability of this recommendation.

Indicate whether statement is true, false, or uncertain, and briefly give your reason.

A firm has a monopoly in its home market and also sells in a perfectly competitive world market; if its home-market price is 50% above the world market price, the elasticity of demand in the home market must be 3.

If a multiplant firm has to produce a given quantity of output, it will never pay it to produce in more than one of its plants if that plant has decreasing marginal costs.

The development of more rapid urban transport will inevitably raise the aggregate rental value of urban residential property.

If the number of acceptable applicants for admission to medical schools is less than the number that could be accepted, the medical profession cannot be raising its earnings by artificially restricting entry.

The rate of interest is determined by the marginal productivity of capital.

If a particular commodity is subject to a special tax not imposed on other commodities, removal of that tax will always increase economic welfare.

If the supply curve of a competitive industry has a positive slope, it means that the industry is subject to decreasing returns to scale.

If wage rates, on the average, increase at the same rate as average product per worker, this means that the marginal return on investment declines over time.

Entrepreneurs in a competitive industry may realize short term gains or profit as a result of an increase in the price of an input (due to a shift in the supply function for the input), even if the demand curve for the industry remains unchanged.

A. A drug manufacturer stated that the prices of drugs sold in England were priced at about one half the price of similar drugs in the United States. The reason given for the price difference was that per capita incomes were much lower in England than in the United States and the English could not afford to pay as much for the drugs.

Accept the factual statements as valid. Discuss the statement in terms of:

Demand functions for drugs in the two countries (income and price elasticities).

Whether the manufacturer could be maximizing his profits.

International trade restrictions on drugs in the two countries.

B. In a given competitive industry, both price and output increase between two time periods. Indicate why each of the following statements is consistent or inconsistent with the observed changes in price and output or is simply irrelevant:

The industry has a perfectly elastic supply curve.

The demand curve has shifted to the right.

The factor supply curves are upward sloping.

The industry is subject to diminishing returns.

Total revenue has increased because the price elasticity of demand is greater than unity.

Rents and quasi-rents have increased.

Indicate whether you believe each of the following statements to be true, false, or uncertain. In each case write a few sentences explaining your answer. Your grade will depend heavily on your explanation.

A monopolist can always get more revenue from a consumer by a fixed sum plus price-per-unit system of charging than by the price-per-unit alone.

The New York, Ridgewood, and Exurban Railroad operates a commuter passenger service. Two kinds of reduced fares are offered: (1) children under 12 years of age ride at half-fare at all times. (b) on Wednesdays there are special half-fare tickets for adults good on trains leaving after 10:00 a.m. and returning before 4:30 p.m. The railroad has been accused by the New Jersey Commerce Commission of being a discriminating monopolist. Can you defend it against this charge with respect to either or both of its half-fare arrangements? If it is in fact a discriminating monopolist with respect to either arrangement, is it promoting an inefficient use of resources by its pricing practices?

It is widely argued that entrepreneurs engaged in a number of different activities somehow have a “competitive advantage” over entrepreneurs engaged only in one even if no technical economies are achieved by combining the activities. This general argument and the supposed advantage take many different forms: sometimes it is that one activity provides a “guaranteed” market for another activity; sometimes that one activity provides financing or capital for another; sometimes that a monopoly in one line confers an advantage in another. A recent example of this reasoning is contained in a report by The Chicago Daily news financial columnist on November 20, 1951 that Sears-Roebuck had completed an arrangement with Kaiser-Frazer to market an automobile under the name of “Allstate.” The columnist commented “also there is the Allstate Insurance Company, a wholly owned subsidiary, which would benefit heavily through liability and other policies written in connection with the sales of an Allstate automobile….Some of the gossip around Detroit has been to the effect that the Allstate would have Sears batteries and tires and certain other Sears accessories as original equipment—which would mean more business for these departments of the company.”

(a) The key question is, of course, whether the financial incentive to Sears to market an automobile is greater because it owns the subsidiary companies than it would be if it did not own them. You will find it helpful in answering this question to consider first two intermediate questions: (b) Given that Sears does own the subsidiary companies and that it is going to market an automobile under its name, is it in its own interests to require that the car be equipped with accessories produced by its companies? (c) To require that cars it sells be insured by its own insurance company?

In answering both questions (a) and (b), consider separately two cases: (1) The subsidiary companies can be regarded as operating under highly competitive conditions; (2) the subsidiary companies can be regarded as having a monopoly of the products they produce. Do the conclusions depend on the assumption made about competitive conditions? Assume throughout that there are no “technical” economies from combining the various activities.

Give brief (a sentence or two) comments to the following:

(a) Demand curves tend to be more elastic in the long run than in the short run.

(b) Men (persons) do not differ significantly from roaches.

(c) Unemployment means that there are not enough jobs to go around.

(d) The tendency for mechanics to charge women higher prices for a given emergency repair than that charged men.

An urban rapid-transit line runs crowded trains (200 passengers per car) at rush hours, but very empty trains (ten passengers per car) at off peak hours. A management consultant makes the following argument:

“The cost of running a car for one trip on this line is about $50 regardless of the number of passengers. So the per passenger cost is about 25¢ at rush hour but rises to $5 per passenger in off peak hours. Consequently, we had better discourage off-peak hour business.”

Explain the fallacy. “Commutation tickets” sold by some transit systems (reduced-price, multiple-ride tickets) are predominantly used in rush hours. Are such tickets a good idea?

Assume that men and women are equally productive in a certain occupation but the conditions of supply between men and women differ is not numerically different). Produce an argument showing that the profit maximizing firm will engage in wage discrimination between men and women. Make sure you explain the supply differences.

Write a very short comment on each of the following questions:

(a) “Fishing in the ocean leads to too many resources being devoted to fishing.” First explain what is meant by “too many.”

(b) Tourists in foreign countries pay higher prices for a given item than do the indigenous residents.

(c) Mechanics tend to charge women higher prices for a given emergency repair than that charged men.

(d) Why might it be legal for anyone to give free medical advice but if he is going to charge for medical advice he needs a license.

(e) “Thou shalt not plow with an ox and an ass together.”

Using elementary economic theory, write short explanations to the following statements:

(a) Tourists must be more careful buying Maine lobsters in Maine than buying Maine lobsters in Philadelphia.

(b) There are proportionally fewer members of minority groups employed in regulated industries than in unregulated industries.

(c) Fishing in the ocean leads to too many resources being devoted to fishing. (First explain what is meant by too many.)

Construct a model of the price discriminating monopolist who sells in two markets. Show the quantities and prices for both markets that will maximize profits. What are the necessary conditions for price discrimination? Does price discrimination lead to a more “socially desirable” outcome? Explain.

Given two isolated markets supplied by a single monopolist, let the two corresponding demand functions be:

$P_1=12-Q_1$ and $P_2=20-3Q_2$

The monopolist’s total cost function is:

$C=3+2(Q_1+Q_2)$

(a) What will the prices be in each market?

(b) What will be the quantity sold in each market?

(c) What will be the total profits earned by the monopolist?

Price discrimination may lead to more efficient allocation of resources. Do you agree or disagree? Explain first what you mean by efficient allocation of resources.

Except for promotional purposes, and price wars, airfare rates to Europe are higher in the summer than in the winter. Coach class airfare from Philadelphia to Los Angeles is cheaper than coach class airfare to Des Moines. First class airfare is always higher than coach class. Moreover, airlines charge lower fares to those who book seats well ahead of time than those who wait until the last minute. Are these all examples of price discrimination? What additional information may be required before you can give a complete answer to this question? Explain.

Give brief answers to each of the following:

(a) “Since a monopolist is the only supplier of a well-defined product, there is no limit to the price it may charge.” Is this statement true or false?

(b) Explain why a monopolist will never set a price (and produce the corresponding output) at which the demand is price-inelastic.

(c) “The ultimate monopoly product would be one whose cross elasticity of demand, with respect to any and all other products, was zero.” Comment.

(d) “The reason movie theaters charge youngsters and oldsters less than the rest of us is because theater owners want to help these two low-income groups.”

Some time ago, most of the major airlines issued student travel cards at a nominal price. These cards permitted college students to fly “space available” (that is, no reservations allowed) at substantial discounts. When this practice was in effect, some older non students were using the cards, and some students were insuring themselves available space by reserving seats for fictitious passengers who then do not show up for the flight.

(a) Did the discount represent price discrimination?

(b) Did the conditions necessary for a successful price discrimination exist?

Give brief answers to each of the following:

(a) “Since a monopolist is the only supplier of a well- defined product, there is no limit to the price it may charge.” Is this statement true or false?

(b) Explain why a monopolist will never set a price (and produce the corresponding output) at which the demand is price-inelastic.

(c) “The ultimate monopoly product would be one whose cross elasticity of demand, with respect to any and all other products, was zero.” Comment.

(d) “The reason movie theaters charge youngsters and oldsters less than the rest of us is because theater owners want to help these two low-income groups.”