Economics 106P

UCLA
E. McDevitt
STUDY QUESTIONS SET #2

PRICING
1. a. What conditions make price discrimination possible?
b. A monopoly can sell its good in the US, where the elasticity of demand is -2, and in South Korea, where
the elasticity of demand is -4. Its marginal cost is $10. At what price does the monopoly sell its good in
each country if resales are not possible?
2. A dominant firm has a market share of 50%. The market elasticity of demand (ηM ) is -2 and the
elasticity of supply of the fringe firms (ε) is 4. The dominant firm has a marginal cost of $2. What is the
profit-maximizing price?
3. a. What is 3rd-degree price discrimination? Under what conditions is it profitable?
b.A monopolist is deciding how to allocate output between two markets. The two markets are separated
geographically (East and West). The demand curves for each market are PE = 20 - QE and PW = 30 - 2QW
The monopolist's total cost function is TC = 4 + 4Q. What are price and output in each market if the firm
can price discriminate? What are total profits? Show this on graphs.
4. A monopolist faces the following two demand curves: P1 = 100-Q1 and P2 = 80-Q2. Marginal cost
is given as MC = 6 + 3Q. Fixed costs are zero.
a. Assuming the conditions for 3rd-degree price discrimination are satisified, find the profit-maximizing set
of quantities and prices under third-degree price discrimination. What is profit? Graph your answers.
b. Suppose the firm was constrained to charge one price to all consumers. What is the profit-maximizing
quantity and price? What is profit? Graph your answers.
5. This question is on 2nd-degree price discrimination. A quantity-discriminating monopoly faces the
demand curve P = 90-Q. Marginal cost is fixed at $30. This firm plans on a charging price P1 for the first
Q1 units (first block), P2 for Q2-Q1( second block), and P3 for Q3-Q2 (third block). Q3 is the total amount
purchased. Find profit-maximizing Q1, Q2, Q3, P1,P2, and P3. What is total profit? How does it compare to
total profit for a non-discriminating monopolist? Show the above answers on a graph.
6. This question is on peak-load pricing. A movie theater faces the following demand curves:
Daytime demand is P = 10-0.1Q and nighttime demand is P = 24 -0.1Q , where P = price of a ticket.
The marginal cost of an additional viewer is 0, but the theater only has 100 seats. What are the profit-
maximizing prices for daytime and nighttime consumers? Draw a graph of the above.
7. This question is on two-part tariffs. As the owner of the only tennis club in a small community, you must
decide on membership dues and fees for court time. There are two types of players. “Serious” players have
demand: Q1= 10 – P where Q1 is court hours per week and P is the fee per hour for each individual
player. There are also “occasional” players with demand: Q2= 8-P.
Assume there are 10 players of each type. You have plenty of courts, so that the marginal cost of court time
is zero. You have fixed costs of $400 per week. Serious and occasional players look alike, so it must charge
them the same prices.
a. Suppose that you want to limit membership to ONLY serious players. How should you set the weekly
membership dues and court fees to maximize profits, keeping in mind the constraint that only serious
players choose to join? What are your profits?
b.You are informed that you can make more profit by encouraging both types of players to join.
Is this correct? What weekly membership dues and court fee maximizes profits? What are these profits
per week?
c. Suppose that over time the number of serious players increase to 30, whereas the number of occasional
players remains at 10. Is it still profitable to cater to the occasional players? Find the profit-maximizing
weekly membership fee and court fee? What are profits per week?
8. This question is on two-part tariffs and packaging. Assume the following: The demand curve for a low
demander is Q1= 20-P and the demand curve for the high demander is Q2 =23-P. There are two high
demanders and one low demander. MC = 2. Show work in answering each question below.
a. Find the profit-maximizing P and L in the case of a single two-part tariff. What is profit?
b. Find the profit-maximizing set of price schedules in the case of 2 two-part tariffs. What is profit?
c. Show that outcome in the case of 2 two-part tariffs can be replicated by a strategy in which the good is
offered in two package sizes.
d. Show how profit can be even greater in the case of packaging versus the 2 two-part tariff scheme.
9. This question is on bundling. Suppose an automotive firm knows that there are three consumers who
value air conditioners and power brakes differently. Assume the firm is not allowed to charge different
prices to different consumers. The table below lists the maximum amount each consumer is willing to pay
for air conditioners and power brakes. The firm's costs are zero.
Consumer Air Conditioner Power Brakes
1 $1,000 $500
2 $800 $300
3 $100 $800
a. If the firm sells air conditioners separately, then what would be the profit maximizing price and what are
profits at this price? If the firm sells power brakes separately, then what would be the profit maximizing
price and what are profits at this price?
b. Suppose the firm sells these goods as a bundle. What is the π-maximizing price for a bundle? What is π?
c. What is profit if the firm sells brakes and air cond. separately at a price of $800 each but offers a special
options bundle for $1,100?
10. This question is on bundling. Consider the following values that four consumers place on good 1 and
good 2. Consumer Good 1 Good 2
A $50 $150
B $80 $120
C $120 $80
D $150 $50
Assume the marginal cost of producing each good is $60.
a. What is the profit-maximizing price for each good if they are sold separately?
b. What is the profit-maximizing price for a bundle under pure bundling?
c. What is the profit-maximizing price for a bundle and for each good separately under mixed bundling?
11. Two two-part tariff question.
P

c d assume that these two triangles are small enough to ignore.

P
e f
P-δ i
j
g h area j includes this small triangle.

MC

D1 D2 Q

Assume that the seller is initially charging a user fee of P and an entrance of area C to both the low
demander and the high demander. The seller now decides to adopt a two two-part tariff scheme.
Demonstrate (by filling in the table below) that this firm can always increase its profit by offering a second
price schedule to the high demander that charges a user of fee of P-δ (and some corresponding L).
For High Demander
At Initial User Fee of P At user fee of P-δ. Change=after - before
Entrance Fee (L)
.
(P-MC)(Q2)
.
Profit from HD
12. Two two-part tariff question.
P

c d assume that these two triangles are small enough to ignore.

P1+δ
e f
P1 i
k
g h j m area k includes this small triangle.
P2

MC

D1 D2 Q

Assume a two two part tariff scheme where the initial user fees are P1 and P2. (You can determine L1 and L2
at these user fees). There is one low demander and one high demander. The profit-maximizing P1 occurs at
the value where dπ/dP1 = dπLD/dP1 + dπHD/dP1 = 0 or where -(dπLD/dP1 ) = dπHD/dP1 . Given that the high
demander chooses price schedule two (P2 = MC), using the tables below demonstrate that this condition
holds when h = f.

For the low demander For high demander (given that P2=c)
At P1 At P1+δ Change At P1 At P1+δ Change
L1 L2
(p1-c)(Q1) (p2-c)(Q2)
πLD πHD

ANSWERS TO PRICING QUESTIONS

1. a. First, the firm must have some degree of market power, b. Resale of the good must be difficult, and
c. The firm must be able to identify (or the consumers have to implicitly identify themselves) the different
groups of buyers that it wants to price discriminate against.
b. PUS = MC/[1+ (1/eUS)] = $10/[0.5] = $20
PSK = $10/[0.80] = $13.33
2. First, find the elasticity of demand for the dominant firm.
ηD = ηM [1/M.S.] - ε [1/M.S. - 1]
= (-2)[1/0.5] - 4[(1/0.5) - 1] = -4-4= -8
Next, P = MC/[1+ (1/eD)] = $2/[7/8] = $2.29
3. a. 3rd-degree price discrimination exists when (P1/MC1) is not equal to (P2/MC2). It is profitable if the
elasticity of demand differs across buyers.
b. MRE = 20 - 2QE and MRW = 30-4QW
MC = dTC/dQ = 4
Set MR in each market equal to MC and solve for quantities in each region.
4= 20 - 2QE and 4 = 30-4QW
QE = 8 and QM = 6.5
PE = 20 - 8= $12 and PW = 30 - 2(6.5) = $17.
Profit = ($12)(8)+ ($17)(6.5) - [4+4(14.5)] = $144.5
Alternatively, we can solve for quantities by setting up the total profit function:
π = (PE)(QE) + (PW)(QW) - TC
= (20 - QE )(QE) + (30-2QW)(QW) - 4 - 4QE-4QW
Take derivatives with respect to the quantities….:
dπ/dQE = 20 - 2QE - 4 = 0 which gives us QE = 8
dπ/dQW = 30 - 4QW - 4 = 0 which gives us QW = 6.5

4a. First, we need to horizontally sum the MR curves. From P1 = 100-Q1 and P2 = 80-Q2, we have
MR1 = 100-2Q1 & MR2 = 80-2Q2. Solving for the quantites gives us Q1 = 50-0.5MR1 and Q2 = 40-0.5MR2.
Adding these together gives us Q = 90 – MR, or MR = 90-Q (This equation is for all quantites past 10
units. Recall that there is a kink in the MR curve. The equation for quantities less than 10 units would
simply be MR1 = 100-2Q1 ).
Second, set MR = MC and solve for Q. MR = 90-Q = MC = 6 + 3Q. This gives us Q = 21. [Note: since
this quantity is greater than 10 (where the kink in the MR curve occurs) we have found the profit-
maximizing quantity]
Third, at Q=21 find MR. MR = 90-Q = 90-21=69.
Fourth, Plug $69 into MR1 = 100-2Q1 & MR2 = 80-2Q2 and solve for Q1 and Q2.
69= 100-2Q1 & 69 = 80-2Q2. Q1 = 15.5 and Q2 = 5.5.
Fifth, Plug the respective quantities into P1 = 100-Q1 and P2 = 80-Q2 and solve for prices.
P1 = 100-15.5 = $84.5 and P2 = 80- 5.5 = $74.5.
Sixth, Total profit = P1Q1 + P2Q2 – TC. TC is found by integrating over the MC function with respect to Q.
TC = 6Q + 1.5Q2 (recall that fixed costs are zero).
π = (84.5)(15.5)+(74.5)(5.5) – 6(21) – 1.5(21)2 = 1,309.75+409.75 – 787.5 = $932.
b. First, we must horizontally sum the demand curves. P1 = 100-Q1 and P2 = 80-Q2 can be rewritten as
Q1 = 100-P1 and Q2 = 80-P2 . Adding these together gives us Q = 180 – 2P, or P= 90-0.5Q.
Second, find the MR function corresponding to this market demand curve. MR = 90-Q. This is the MR
function for all quantities greater than 20 units. At 20 units there is a kink in the market demand curve, and
there will therefore be a discontinuity in the MR curve. For units less than 20, the MR function is described
by the high demanders marginal revenue function, namely MR1 = 100-2Q1 .
Third, assuming it is most profitable to sell to both, set MR = MC and solve for Q.
90-Q = 6 + 3Q, or Q = 21.
Fourth , find price and profit. P = 90-0.5Q = 90-0.5(21) = $79.5.
Profit = PQ – TC = (79.5)(21)- 6(21)-1.5(21)2 = $1,669.5 – 787.5 = $882.
Fifth, assuming that it is most profitable to sell only to the high demander (recall that the MC crosses the
discontinous MR curve twice), set MR1 = 100-2Q1 = MC and solve for Q. 100-2Q=6+3Q,or Q=18.8.
Sixth, Find price and profit. P = 100-Q = 100-18.8= $81.20. Profit=(81.2)(18.8)-6(18.8)-1.5(18.8)2 =
1,525.56-642.96= $882.60. Hence, given that constraint that a single price will be charged to all consumers,
it is more profitable to set the price at $81.20 and sell only to the high demander.
5. π = P1Q1 + P2(Q2-Q1) + P3(Q3-Q2) - (MC)(Q3)
Solve for Q1, Q2, and Q3, and then plug back into demand equation to get prices.
By substitution:
π = (90-Q1)Q1 + (90-Q2)(Q2-Q1) + (90-Q3)(Q3-Q2) - 30Q3
Take derivative with respect to all quantities and set equal to zero:
1. dπ/dQ1 = (90-2Q1)- 90 + Q2 = 0 or, Q2 = 2Q1
2. dπ/dQ2 = (90-Q2) -Q2+Q1 -90 + Q3 = 0 or, Q3 + Q1 = 2Q2.
3. dπ/dQ3 = (90-Q3) - Q3 +Q2-30 = 0 or, 30+0.5Q2 = Q3.
Equation (3) into equation (2) gives us: (30+0.5Q2 )+ Q1 = 2Q2 or, Q1 = 1.5Q2 -30
then equation (2) into equation (1): Q2 = 2(1.5Q2 -30) = 3Q2 -60 , or Q2 = 30
By equation (1) we get Q1=15 and by equation (3) we get Q3=45.
To find prices for each block:
P1 = 90-15= $75 P2 = 90-30= $60 P3 = 90-45= $45
Profits= ($75)(15) + ($60)(30-15) + ($45)(45-30) - ($30)(45) = $1,350
For non-discriminating monopolist: MR = 90-2Q
Set MR = MC Æ 90-2Q = 30 and we get Q =30.
P = 90 - 30 = $60.
Profit = ($60-$30)(30) = $900
6. For daytime: MR = 10-0.2Q which when set equal to MC = 0 gives us Q = 50 (which does not exceed
capacity). Plugging this into the demand curve gives P = 10- 0.1(50)= $5.
For nighttime: MR = 24-0.2Q = 0 Æ Q = 120. Since this quantity exceeds capacity, the theater will
charge the highest price possible for 100 seats: P = 24-0.1(100) = $14.
7. Set count fee (P) equal to marginal cost and set a weekly membership dues equal to CS of serious
players at this P. Let L = weekly membership dues. L = CS = ½(10-P)2 . Since P is set equal to MC which
is zero: L = $50.
Profit = 10L + (P-MC)(Q1) – fixed costs = $500 + 0 - $400 = $100 per week.
b. Compare profits for L = CS2 (low demanders) and L = CS1 (high demanders). We have already done the
second part of this in part (a), so we need only calculate profit when L = CS2
Set L = CS2 (low demanders)
Step 1: Set up profit function…..
π =nL + (P-MC)(Q1+Q2) – Fixed Costs. n= total number players who pay membership fee(L).
π =20L + (P-MC)(Q1+Q2) – Fixed Costs.
= 20L + (P)[10(10-P) + 10(8-P)] -$400 [recall there are 10 players of each type so Q1 and Q2 are
multiplied by 10]
= 20[1/2(8-P)2] + (P)[180-20P] - $400
= 10(8-P)2 + 180P – 20P2 - $400
Step 2: Take derivative with respect to P…
dπ/dP = (-20)(8-P) + 180 – 40P = 0
= -160 + 20P-40P + 180 =0
= 20 - 20P = 0
or P= $1 per hour of court time, and L = [1/2(8-1)2] = $24.5 per player per week
Step 3: Plug in these values of P and L and calculate weekly profit.
Profit = 20L + (P)[10(10-P) + 10(7-P)] -$400
= 20(24.5)+ ($1)[(180-20(1)] -$400 = $250 per week.
Notice that this profit is higher than when you price to only admit serious players.
c. You need to compare the following situations: L = CS1 versus L = CS2.
CASE 1: Set L = CS2 (low demanders)
Step 1: Set up profit function…..
π =nL + (P-MC)(Q1+Q2) – Fixed Costs. n= total number players who pay membership fee(L).
π =40L + (P-MC)(Q1+Q2) – Fixed Costs.
= 40L + (P)[30(10-P) + 10(8-P)] -$400 = 40[1/2(8-P)2] + (P)[380-40P] - $400
= 20(8-P)2 + 380P – 40P2 - $400
Step 2: Take derivative…
dπ/dP = (-40)(8-P) + 380 – 80P = 0 Æ = -320 + 40P-80P + 380 =0 Æ = 60 - 40P = 0
or P= $1.50 per hour of court time. L = CS1= [1/2(8-P)2] = ½(8-1.5)2 = $21.125 per player per week
Step 3: Plug in these values for P and L to calculate profit.
Profit = 40L + (P)[30(10-P) + 10(8-P)] -$400 = 40($21.125) + ($1.50)[380-40($1.50)] - $400
= $845+$480 -$400= $925 per week
CASE 2: L = CS1 (high demanders)
Since you are only selling to one group of buyers, set count fee (P) equal to marginal cost and set a weekly
membership due equal to CS at this P.
L = CS = ½(10-P)2 . Since P is set equal to MC which is zero: L = $50.
Profit = 30L + (P-MC)(Q1) – fixed costs = $1500 + 0 - $400 = $1,100 per week.
It is now better to set the user fee equal to MC (zero) and charge membership fee which only attracts the
serious players.

8.a. SINGLE TW0-PART TARIFF.

Case 1: Sell to both types demanders (L= CS1).
First, set up profit function: π = (3)(1/2)(20-P)2 + (P-2)(66-3P).
Next, take the derivative of this function with respect to P, set it equal to zero, and solve for P.
dπ/dP = (-3)(20-P) + (66-3P) + (-3)(P-2) = -60 +66 +6 +3P-3P-3P = 12 – 3P = 0 , or P = $4.
Third, find L. L = ½ (20-P)2 = ½ (20-4)2 = ½ (256) = $128.
Finally, find profit. π = (3)(128) + (4 – 2) (16+38) = 384 + 108 = $492.
Case 2: Sell only to high demanders (L= CS2)
First, π = (2)(1/2)(23-P)2 + (P-2)(46-2P).
Next, dπ/dP = (-2)(23-P) + (46-2P) +(-2)(P-2) = -46 + 46 + 4 +2P-2P –2P = 4 – 2P = 0, or P = $2.
Third, L = ½ (23-2)2 = ½ (441) = $220.5.
Finally, π = (2)(220.5) = $441. Profit is greater when selling to both types of demanders, so profit-
maximizing price schedule is P=$4 and L = $128.
b. 2 TWO-PART TARIFF.
First, set up profit function: π = ½ (20-P1)2 + (P1-2)(20-P1) + 2L2
where L2 = ½(23-2)2 –{ ½(23-P1)2 – ½ (20-P1)2} = 220.5 – ½(23-P1)2 + ½ (20-P1)2
Substituting in for L2:
π = ½ (20-P1)2 + (P1-2)(20-P1) + 2 [220.5 – ½(23-P1)2 + ½ (20-P1)2]
= 1.5(20-P1)2 + (P1-2)(20-P1) + 441 -(23-P1)2 .
Next, dπ/dP1 = (-3)(20-P1) + (20-P1) + (-1)(P1-2) + (2)(23-P1) = 0
= -60 +20 +2 + 46 +3P1 –P1 –P1 –2P1 = 8 –P1 = 0, or P1 = $8
Third, L1 = ½ (20-P1)2 = ½ (20-8)2 = ½(144) = $72.
Fourth, L2 = 220.5 – ½(23-P1)2 + ½ (20-P1)2 = 220.5 – ½ (23-8)2 + ½(20-8)2 = $180.
Finally, π = 72 + (8-2)(12) + 2(180) = $504.
c. PACKAGING
a. First, using the information from the previous parts, determine the price charged to the low demander for
the small package size: P1Q1 + L1 = (8)(12) + 72 = $168. Now find the amount charged to the high
demander for the large package size: P2Q2 + L2 = (2)(21) + 180 = $222.
Charge $168 for a package consisting of 12 units, and $222 for a package consisting of 21 units.
Revenue = 168 + (2)(222) = $612 and Total cost = (2)(12+42) = $108.
Profit = 612-108 = $504. This is the same as the profit in above 2 two-part tariff case.
Second, find the CS of the HD if this demander chooses the small package size:
CSHD (@small package) = TVHD (@small package) – 168 = 23Q – ½ Q2 - 168
= 23(12) – ½ (12)2 – 168 = 276-72-168= $36.
Now find the CS of the HD if this demander chooses the large package size (using the price determined in
step 1):
CSHD (@large package) = TVHD (@large package) – 168 = 23Q – ½ Q2 - 222
= 23(21) – ½ (21)2 – 222 = 483-220.5-222= $40.5.
Third, notice that the high demander receives greater CS by choosing the large package size. This means
the seller can raise the price on this package size by 40.5-36 without causing the HD to switch to the small
package size (i.e. , profit-maximization dictates that the HD should set the price of the large package size so
that CSHD (small package) = CSHD (large package). In the final solution, the seller charges $168 for the
small package size (12 units) and 222+4.5= $226.5 for the large package size (21 units). Compared to the
two two-part tariff outcome profit is greater by $4.5.
9. a. For air conditioners: The maximum revenue of [($1,000)(1), ($800)(2), ($100)(3)] is $1,600. This
occurs when the price is $800.
For power brakes: The maximum of [($500)(2), ($300)(3), ($800)(1)] is $1,000. This occurs when price
is $500. Profit = $1,600+ $1,000=$2,600.
b. For consumer 1 the total value of a bundle is = $1,500, for consumer two it is $1,100, and for consumer
three it is $900.
Maximum of [($1,500)(1), ($1,100)(2), ($900)(3)] is $2,700. This occurs when the price of a bundle is
$900. Profit is $2,700.
c. At a bundle price $1,100 both consumers 1 and 2 will buy the bundle, so revenue from sales of bundles
will be $2,200. Buyer 3 will not buy the bundle, buy will buy the power brakes at $800.
Profit will therefore be $2,200 + $800 = $3,000.
10. Consumer Good 1 Good 2 Total Value
A $50 $150 $200
B $80 $120 $200
C $120 $80 $200
D $150 $50 $200
a. Good 1: Maximize [P= $80 with profit = (80-60)(3); P=$120 with profit = (120-60)(2); P=$150 with
profit = (150-60)(1)] . Maximum profit is $120 which occurs when price of good 1 equals $120. Notice
that I did not try P $50 since it is below marginal cost.
Good 2: Maximize [P= 80 with profit = (80-60)(3); P=$120 with profit = (120-60)(2); P=$150 with profit
= (150-60)(1)] . Maximum profit is $120 which occurs when price of good 2 equals $120.
Total Profit = $240.
b. Under pure bundling, the profit-maximizing price for a bundle is $200. At this price you sell to
all four consumers. Profit = ($200)(4) - $480 = $320. [note: total cost = total cost of good 1 + total cost of
good 2= ($60)(4)+($60)(4)= $480].
c. Notice that the value placed on good 1 by consumer A of $50 is less than its production cost of $60.
Likewise, the value placed on good 2 by consumer D of $50 is below its production cost of $60. Therefore,
in setting its mixed- bundling strategy the firm would like to set the separate prices for these goods such
that A and D would only buy goods 2 and 1, respectively. It does so by offering good 1 for a little less
than $150 (for simplicity assume it is $150) and good 2 for a little less than $150. A bundle can still be
purchased for $200. In this case, B and C still purchase the bundle, but A only buys good 2 and D only
buys good 1. Thus, with P1 = $150, P2 = $150 , Pbundle = $200 it follows that
Profit = [($200)(2) - $240] + [($150)(1) - $60] + [($150)(1)-$60] = $160+ $90 + $90 = $340.

GRAPHS for Question 3b: Question 5:

30 90
East West P1= $75
20 P2= $60
$18
P3=$45
$12
$30 MC
$4 MC
De Dw D
8 20 6.5 15 Qw .
15 30 45 60 90

Question 4b:Same price to all consumers.

$100 MR = 100-2Q.

P=100-Q (for P>$80)

$81.2
MC=6+3Q
$80
$79.5 P=90-0.5Q (for P<$80)
$70

Dmkt.
$60
MR=90-Q

$6
MRmkt.

18.8 20 21 Q

Note: Because there is a kink in the market demand curve, there will be a discontinuity in the market MR
curve. At Q =20, MR=90-Q = 90-20=$70, whereas at Q=20, MR =100-2Q= 100-40=$60.
Graphs for 4a.
$100
$100
MR=100-2Q MC
P1=$84.5
$80 $80
P2=$74.5
MR= $69
MR=90-Q

ΣMR
D1 D2

Q1= 15.5 Q1 Q2= 5.5 Q2 10 Q= 21 Q

MR1 MR2

Kink occurs at quantity of 10 since MR1= 100-2Q1 = $80 at that quantity.

11.
For High Demander
At Initial User Fee of P At user fee of P-δ. Change=after - before
Entrance Fee (L)
c cef +ef .
(P-MC)(Q2) efghi ghij
+j-ef .
Total profit +j
from HD
12. Two two-part tariff question.
P

c d assume that these two triangles are small enough to ignore.

P1+δ
e f
P1 i
k
g h j m area k includes this small triangle.
P2

MC

D1 D2 Q

For the low demander For high demander (given that P2=c)
At P1 At P1+δ Change At P1 At P1+δ Change
L1 ce c -e L2 ceghijkm ceghijkmf +f
(p1-c)(Q1) gh eg +e-h (p2-c)(Q2) 0 0 0
πLD -h πHD +f

Thus, -(dπLD/dP1 ) = - (-h) = h and dπHD/dP1 = f.