Answer the following questions. Your answers must be justified using relevant economic reasoning, including appropriate written and diagrammatic analysis. Make these explanations as clear and concise as possible. Total marks for this quiz: 5 marks.
The table below shows the monthly marginal benefit of movies for two individuals: Jill and Pauline.
($ per unit)
(units a month)
($ per unit)
(units a month)
Suppose the firm’s marginal cost is $2.
We first need to identify its demand curve. To do this we horizontally sum the individual customer’s MB curves. This allows us to fill in the first two columns of the above table.
We need to calculate revenue, which is price times quantity. For example, when price is 24 then 2 units are sold. This generates revenue of 24×2=48.
We also need to calculate MR, which is the increase in revenue when output is increased by 1 unit. For example, when output increases by one unit from 1 to 2, revenue increases from $30 to $28. Hence MR= $48-30 = $18
With discrete units of output, the firm maximising profit by selling all units for which MR>MC.
Thus it is profit maximising to sell 3 units at price $18
The firm would not sell 4 units, because the MR of the fourth unit is $-14, and marginal cost is $2. It therefore would lose $16 by selling 4 units rather than 3 units.
Enter your answer to part b into the table below. Provide an explanation of how you obtained your answer.
In this part the firm can identify each customer, so can set a different linear price for each of them. (That is, it conducts third degree price discrimination.) In this case we can follow the methodology of part b, treating each customer’s as if it were an entire market.
It is profit maximising to sell Jill 2 unit at price $18.
It is profit maximising to sell Pauline 1 unit at price $24.
Enter your answer to part c on this page
When the firm sets a common linear price, as in part b, the profit is $18×3 – $2×3 = $48
When the firm conducts third degree price discrimination, as in part c, it:
- i) gets a profit from Jill of $18×2 – $2×2 = $32
- ii) gets a profit from Pauline of $24×1 – $2×1 = $22
Total profit = $32 +22 = $54.
Price discrimination (i.e segmenting the market) raises profit.
When the firm sets a common price, it is profit maximising to sell 3 units, and it will set price $18. In this case Jill buys 2 units and Pauline 1 unit. If it were to raise price, Jill would only buy one unit. But, if it can price discriminate, it is able to sell two units to Jill for $18. In addition it can raise the price of the unit sold to Pauline by $6 and Pauline will still buy that unit. Thus profit has increased by $6 when the firm can price discriminate.
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