- An airline knows its customers are either business travelers, who book at the last minute, or leisure travelers, who plan trips far in advance. To maximize profit using price discrimination, the airline's optimal strategy would be to:
Answer: offer low fares for advance-purchase tickets and high fares for last-minute tickets.
Business travelers typically have an urgent need to travel and their employer pays, making their demand highly inelastic. Leisure travelers are more flexible and price-sensitive, making their demand elastic. The profit-maximizing strategy is to charge a high price to the inelastic group (last-minute business travelers) and a low price to the elastic group (advance-purchase leisure travelers).
- A university offers discounted football tickets to its students. To ensure this price discrimination strategy is effective, the university requires a valid student ID for ticket purchase and at the stadium gate. This policy is primarily designed to address which potential problem?
Answer: Arbitrage, where students might resell their cheap tickets to non-students.
A critical condition for successful price discrimination is the ability to prevent resale, or arbitrage. If students could easily buy discounted tickets and sell them to the general public for a profit, the market segments would merge, and the university would lose revenue. Requiring ID at purchase and entry is a mechanism to prevent this arbitrage.
- A firm that switches from a single-price monopoly model to a successful price discrimination model will often increase its total output. This is because the ability to price discriminate:
Answer: allows the firm to profitably sell units to new customers with a lower willingness to pay without reducing the price for existing customers.
A single-price monopolist stops producing where MR=MC. To sell more, it would have to lower the price for all customers, which might make the additional sales unprofitable. A price discriminator can keep charging high prices to its inelastic customers while also offering a lower price to a new group of more elastic customers. This makes selling additional units profitable, leading to an increase in total output.
- To successfully practice third-degree price discrimination, a firm must, at a minimum, be able to:
Answer: use a verifiable customer characteristic to separate buyers into groups with different elasticities.
Third-degree price discrimination involves dividing customers into distinct groups and charging each group a different price. To do this, the firm needs a practical, verifiable way to segment the market (e.g., age for a senior discount, student ID for a student discount). This characteristic must also be correlated with differences in price elasticity of demand. (B) describes perfect (first-degree) price discrimination. (A) and (D) are not specific requirements for this type of pricing strategy.
- Under which of the following circumstances could third-degree price discrimination most likely lead to a higher level of total economic surplus compared to a single-price monopoly?
Answer: When price discrimination allows a firm to profitably serve a market that would not be served at all under a single monopoly price.
The effect of price discrimination on efficiency is ambiguous. However, it can definitively increase total surplus (be more efficient) if it increases output. This happens in cases where the single profit-maximizing price is so high that no one would buy the product, but by segmenting the market, the firm can charge a lower price to one group and make a profit. In this case, output goes from zero to a positive amount, creating both consumer and producer surplus where none existed before.
- The primary economic objective for a firm that successfully implements a price discrimination strategy is to:
Answer: transform a portion of what would have been consumer surplus into additional producer surplus.
The fundamental goal of price discrimination is to increase profits. It achieves this by charging customers prices that are closer to their maximum willingness to pay. This process captures consumer surplus (the difference between what a consumer is willing to pay and what they actually pay) and converts it into producer surplus (profit). While output may sometimes increase (making A partially true in some cases), it is a means to an end, not the primary objective. (C) and (D) are incorrect; the strategy complicates pricing and is not primarily about cost reduction.
- A video game company releases a new title for $60. Eight months later, it permanently drops the price to $30. Viewing this as price discrimination over time, a primary consequence of this strategy is that it allows the company to:
Answer: charge a higher price to early adopters with inelastic demand and a lower price to later, more price-sensitive buyers.
This strategy segments the market by time. Early adopters are often die-hard fans or those who are less sensitive to price (inelastic demand) and are willing to pay a premium to play immediately. Later buyers are often more casual, patient, or price-sensitive (elastic demand). By charging two different prices at two different times, the firm captures more consumer surplus from both groups than it could with a single, permanent price.
- A privately-owned museum offers free admission for children under 12 while charging adults $20. From the perspective of price discrimination, the most compelling economic rationale for this policy is that:
Answer: children cannot enter without a paying adult, and free child admission raises adults' willingness to pay for their own ticket.
This is a sophisticated form of price discrimination. The 'product' being sold is a family visit, which requires at least one adult ticket. By making the child's ticket free, the museum isn't just targeting children; it's making the total price of the family outing more attractive to the adult decision-maker. This increases the adult's willingness to pay for their own ticket and makes them more likely to visit, thus maximizing revenue from the paying group (adults). While marginal cost (B) may be low, it doesn't explain why only children are free.
- A movie theater charges $8 for a matinee showing before 4 p.m. and $15 for an evening showing of the same film. For this practice to be considered price discrimination, which of the following must be true?
Answer: The difference in ticket prices primarily reflects the different demand elasticities of afternoon and evening moviegoers.
Price discrimination is charging different prices for the same product where the price difference is not based on cost differences. The core reason for this strategy is to segment the market and charge different prices based on willingness to pay, which is related to price elasticity of demand. Matinee-goers are typically assumed to have more elastic demand. While monopoly power (C) is a necessary condition, (A) explains why the pricing itself is discriminatory. (B) would make it a cost-based pricing strategy, not price discrimination. (D) is a likely outcome but doesn't define the practice.
- A publisher first releases a new novel in a $30 hardcover edition and, a year later, releases a $15 paperback edition. This common practice is a form of price discrimination that relies on the assumption that:
Answer: eager readers who buy the hardcover have a lower price elasticity of demand than those who wait for the paperback.
This strategy uses time to segment the market. Readers who want the book immediately (often avid fans) are less sensitive to price and have a more inelastic demand. They are targeted with the high-priced hardcover. More patient or price-sensitive readers have a more elastic demand and are targeted a year later with the lower-priced paperback. While there is a cost difference (A), it typically does not account for the entire price difference.
- A gourmet grocery store charges $15 per pound for wild-caught salmon and $10 per pound for farmed salmon. This price difference is LEAST likely to be an example of price discrimination if:
Answer: the wholesale cost the store pays for wild-caught salmon is significantly higher.
Price discrimination involves charging different prices for the same good, or for different goods where the price difference does not reflect a cost difference. If the store's cost for wild-caught salmon is much higher than for farmed salmon, the price difference is justified by costs and is not price discrimination. The other options describe conditions (A), demand characteristics (B), or marketing strategies (D) that are consistent with price discrimination.
- Which of the following scenarios is the LEAST likely to be considered an example of price discrimination?
Answer: A car wash charging more for cleaning larger vehicles like SUVs compared to smaller sedans.
Price discrimination requires charging different prices for the same product where the difference is not based on cost. Cleaning a larger vehicle likely requires more time, water, and cleaning materials. Therefore, charging more for an SUV is most likely a cost-based price difference, not price discrimination. The other scenarios are classic examples of second-degree (A), third-degree (C), and third-degree (D) price discrimination.
- A key reason why a wheat farmer operating in a perfectly competitive market cannot engage in price discrimination is that:
Answer: the farmer, as a price taker, has no market power to set different prices for different customers.
A necessary condition for price discrimination is market power, i.e., the ability to set prices. In a perfectly competitive market, firms are price takers; they must accept the market price. If a farmer tried to charge one customer a higher price, that customer would simply buy identical wheat from another farmer at the market price. Therefore, the inability to set prices is the fundamental barrier.
- A coffee shop provides a loyalty card that gives a customer a free coffee after they purchase ten coffees. This practice can be classified as a form of price discrimination because it:
Answer: effectively offers a lower average price per cup to high-frequency buyers than to low-frequency buyers.
This is a form of second-degree price discrimination, where price varies by quantity consumed. By offering a free coffee after ten purchases, the average price per cup for a loyal customer (who buys 11 cups) is lower than for an occasional customer (who buys only one). It is price discrimination based on the quantity purchased over time. While it does build loyalty (C), its economic mechanism is price discrimination.
- If a monopolist were able to practice perfect (first-degree) price discrimination, which of the following outcomes would occur?
Answer: The firm's marginal revenue would be equal to the price of the last unit sold, making the demand curve its MR curve.
Under perfect price discrimination, the firm charges each customer their maximum willingness to pay. This means the firm does not have to lower the price on all previous units to sell one more unit. The revenue gained from selling an additional unit is simply the price that new customer pays. Therefore, the marginal revenue (MR) for each unit is equal to its price, which means the market demand curve also becomes the firm's MR curve. This leads the firm to produce the allocatively efficient quantity (where P=MC), eliminating deadweight loss but also all consumer surplus.
- An electric utility charges residential customers $0.12 per kilowatt-hour for the first 500 kWh and $0.09 for each additional kWh per month. This pricing model is a form of second-degree price discrimination intended to:
Answer: charge a higher price for the block of electricity that consumers demand most inelastically.
This is second-degree price discrimination (pricing by quantity). The first 500 kWh likely cover essential needs (lighting, refrigeration), for which demand is highly inelastic. Subsequent usage (e.g., extra appliances) is more discretionary, making demand more elastic. The utility captures more consumer surplus by charging a high price for the essential, inelastically demanded units and a lower price for additional, elastically demanded units.
- A new cafe opens in a busy downtown area with dozens of other coffee shops. The cafe tries to price discriminate by offering a 10% discount to employees of a specific nearby company. This strategy is likely to be ineffective primarily because:
Answer: in a highly competitive market, the cafe lacks the market power to maintain higher prices for other customers.
Price discrimination requires market power. In a market with many competitors (monopolistic competition or approaching perfect competition), a firm has very little ability to set prices. If the cafe charges a higher, non-discounted price, customers can easily walk to a competitor next door. The intense competition erodes the market power needed to sustain price differences.
- A local hair salon offers a 20% discount to senior citizens on Tuesdays. This strategy is unlikely to be profitable unless which of the following conditions holds true?
Answer: The salon can effectively segment its customers and has some degree of market power.
For any price discrimination scheme to be profitable, two conditions are essential: the firm must have some market power (it can't be a price taker) and it must be able to segment its market (identify groups with different elasticities and prevent resale). (A) describes cost-based pricing, not price discrimination. (B) describes the expected demand characteristic but is not the fundamental requirement for the strategy to work. (D) suggests a competitive market where price discrimination is difficult or impossible.
- A pharmaceutical company sells a patented medication at a high price in wealthy nations and a much lower price in poorer nations. For this to be a profit-maximizing strategy, the company must believe that the demand for the medication in poorer nations is:
Answer: more price-elastic compared to the demand in wealthy nations.
The rule for profit-maximizing price discrimination is to charge a lower price to the group with more elastic demand and a higher price to the group with more inelastic demand. Consumers in poorer nations likely have lower incomes and are more sensitive to price changes, resulting in more price-elastic demand. Wealthy-nation consumers are less sensitive to price, meaning their demand is more inelastic.
- A concert promoter offers discounted tickets to local university students, but the strategy fails to increase profits because students are reselling their tickets to the general public at a higher price. This failure is most directly attributed to the promoter's inability to:
Answer: prevent arbitrage between the two designated market segments.
One of the three necessary conditions for successful price discrimination is preventing resale or arbitrage. When the low-price group (students) can easily sell the product to the high-price group (the general public), the firm's ability to keep the markets segmented breaks down. This undermines the entire strategy, as the firm ends up selling many tickets at the low price that are ultimately consumed by the high-price group.
