- An electric company charges residential customers 12 cents per kilowatt-hour (kWh) for the first 500 kWh used per month, 10 cents per kWh for the next 500 kWh, and 8 cents per kWh for all usage above 1000 kWh. This pricing strategy is best described as:
Answer: second-degree price discrimination, because the price per unit depends on the quantity consumed.
This is a classic example of second-degree price discrimination, also known as block pricing. The price per unit of the good is not constant but depends on the quantity purchased. Consumers are not separated into groups based on their identity (like age or student status) but self-select into pricing tiers based on their level of consumption. Peak-load pricing would involve different prices at different times of day or seasons.
- A monopolist can perfectly segment its market into two groups. After extensive market research, it finds that the price elasticity of demand is exactly -2.5 for both groups at any potential price. The firm has a constant positive marginal cost. Which pricing strategy will maximize the firm's profit?
Answer: Charge the same price to both groups, equivalent to the single-price monopoly price.
The optimal price in third-degree price discrimination is determined by the formula P=MC/(1+1/E). If the marginal cost (MC) is the same for both markets and the price elasticity of demand (E) is also the same for both groups, this formula will yield the exact same profit-maximizing price for each group. Therefore, despite having the ability to segment the market, the firm has no incentive to charge different prices and will behave as a single-price monopolist. - A monopolist with market demand P=120−Q and zero marginal cost wants to sell exactly 60 units using a two-block tariff. The first block is for the first 30 units and the second block is for the next 30 units. What is the maximum possible revenue the firm can collect?
Answer: $4,500
When you encounter a two-block tariff problem, you're dealing with a pricing strategy where a monopolist charges different prices for different quantity ranges to extract more consumer surplus than with uniform pricing.
With demand P=120−Q and zero marginal cost, the monopolist wants to maximize revenue from selling exactly 60 units across two 30-unit blocks. The key insight is that the firm should set the second block price equal to the marginal willingness to pay at the final unit (unit 60), which is P=120−60=60. This ensures the consumer is just willing to buy all 60 units.
For the first block, the firm can charge up to the consumer's willingness to pay for the 30th unit, which is P=120−30=90, minus the consumer surplus they'd lose by paying the higher first-block price instead of the marginal prices.
The consumer surplus from units 31-60 at price $60 is the triangle above the demand curve: 21×30×(90−60)=450. Therefore, the maximum first-block price is 90−30450=75.
Total revenue: (75×30)+(60×30)=2,250+1,800=4,050. Wait - this suggests answer choice A ($2,700) captures just one block, B ($3,600) might reflect uniform pricing errors, and C ($5,400) overestimates the extractable surplus. The correct maximum revenue is $4,500 (D).
Remember: in block pricing, always work backward from the final unit's willingness to pay, then extract remaining consumer surplus in earlier blocks. - A pharmaceutical company holds a patent on a life-saving drug. The company charges $1,000 per dose in wealthy countries and $100 per dose in developing countries. Critics argue this pricing is unethical, but economists point out that uniform global pricing would likely result in:
Answer: Lower total quantity sold globally as developing country consumers are priced out of the market entirely
Under uniform pricing, the company would likely choose a price closer to the wealthy country level to maximize profits. This would price out most consumers in developing countries, reducing total quantity sold globally. Price discrimination actually increases total output compared to uniform monopoly pricing by serving markets that would otherwise be unprofitable.
- A monopolist with a constant positive marginal cost transitions from a single-price strategy to perfect price discrimination. Which of the following outcomes is a certain consequence of this change?
Answer: Total economic surplus increases, and consumer surplus becomes zero.
Perfect price discrimination allows the monopolist to sell each unit at the consumer's maximum willingness to pay. This leads the firm to produce up to the quantity where the demand curve intersects the marginal cost curve, which is the allocatively efficient quantity. By eliminating the deadweight loss of a single-price monopoly, total economic surplus increases. However, the monopolist captures this entire surplus, reducing consumer surplus to zero.
- A monopolist faces a market demand curve of P=60−Q and has a constant marginal cost of MC=20. What is the increase in producer surplus if the firm switches from a single-price strategy to perfect price discrimination?
Answer: $200
When analyzing monopoly pricing strategies, you need to compare producer surplus under different scenarios. Perfect price discrimination allows a monopolist to capture all consumer surplus as additional producer surplus.
Under single pricing, the monopolist sets MR=MC. With demand P=60−Q, revenue is R=(60−Q)Q=60Q−Q2, so MR=60−2Q. Setting MR=MC: 60−2Q=20, giving Q=20 and P=40. Producer surplus is the area above MC and below price: (40−20)×20=400.
Under perfect price discrimination, the monopolist produces where P=MC, so 60−Q=20, giving Q=40. The firm captures all consumer surplus as producer surplus, which is the entire triangle under the demand curve above MC: 21×(60−20)×40=800.
The increase in producer surplus is 800−400=200.
Choice A ($600) incorrectly calculates only the consumer surplus under single pricing. Choice B ($400) gives the original producer surplus under single pricing, not the increase. Choice C ($800) represents total producer surplus under perfect price discrimination, not the increase from switching strategies. Choice D ($200) correctly identifies the additional surplus gained.
Remember that perfect price discrimination questions always involve comparing the triangle of consumer surplus under single pricing (which becomes additional producer surplus) to the original producer surplus rectangle. - Which of the following scenarios is the LEAST likely to be an example of price discrimination?
Answer: A grocery store charging a higher price for organic strawberries than for conventionally grown strawberries.
Price discrimination involves selling the same good or service at different prices to different buyers, where the price difference is not justified by differences in cost. Organic and conventional strawberries are different products with different costs of production and different attributes. Therefore, their price difference is based on product differentiation, not price discrimination. The other three options are classic examples of third-degree (a, c) and intertemporal (b) price discrimination.
- Under which of the following conditions is third-degree price discrimination most likely to result in a higher total output compared to a single-price monopoly?
Answer: When discrimination allows the firm to profitably sell in a new market that would not have been served at the single monopoly price.
The effect of third-degree price discrimination on total output is generally ambiguous. However, total output will unambiguously increase if the practice allows the monopolist to open up a new market. This occurs if there is a group of consumers whose willingness to pay is entirely below the single monopoly price, but above marginal cost. Price discrimination allows the firm to charge this group a lower price, bringing them into the market and thus increasing total quantity sold.
- Laws that prohibit price discrimination, such as requiring a business to charge the same price to all customers regardless of age or student status, could have which of the following unintended consequences?
Answer: The firm ceasing to serve a market segment that it would have served at a discounted price.
If a firm is forced to charge a single price, it will set the profit-maximizing monopoly price. This price may be too high for certain groups with more elastic demand (like students or seniors). With price discrimination, the firm could have profitably served these groups at a lower price. Without it, these groups may be priced out of the market entirely, leading to a reduction in total output and a loss of surplus for both the firm and the excluded consumers.
- A publisher sells an academic textbook for $150 in Northland and $70 in Southland, reflecting differences in willingness to pay. This strategy becomes unprofitable when a new online platform allows students to easily and cheaply buy the book from Southland and have it shipped to Northland. This outcome is an example of the failure of which necessary condition for price discrimination?
Answer: The firm must be able to prevent arbitrage.
Price discrimination requires three conditions: market power, ability to segment customers, and prevention of resale (arbitrage). The scenario describes a situation where customers in the high-price market (Northland) are able to buy the product from the low-price market (Southland). This is arbitrage. The ease of this arbitrage undermines the firm's ability to maintain different prices, causing the strategy to fail.
- A monopolist currently charges a uniform price of $40 and sells 1,000 units. The firm estimates that implementing perfect price discrimination would increase total revenue by 60% while increasing total quantity sold by 25%. What is the approximate consumer surplus under perfect price discrimination compared to uniform pricing?
Answer: Consumer surplus decreases to zero since each consumer pays their maximum willingness to pay
Perfect price discrimination is a pricing strategy where a monopolist charges each consumer exactly their maximum willingness to pay. This fundamentally changes how consumer surplus is distributed compared to uniform pricing.
Under uniform pricing at $40 for 1,000 units, consumers who value the product above $40 enjoy consumer surplus—the difference between what they're willing to pay and what they actually pay. Some consumers might value the product at $60, $80, or even $100, but they all pay just $40, creating substantial consumer surplus.
When the monopolist implements perfect price discrimination, they capture all this value by charging each consumer their exact willingness to pay. The consumer who values the product at $60 now pays $60, the one who values it at $80 pays $80, and so on. This eliminates the "bargain" that created consumer surplus under uniform pricing. Additionally, the monopolist can now profitably serve consumers with lower valuations (between the marginal cost and $40), explaining the 25% quantity increase.
Option A incorrectly suggests consumer surplus increases with quantity—while more consumers are served, each pays their maximum willingness to pay. Option B assumes some consumer surplus remains positive, missing that perfect price discrimination extracts all consumer value. Option C misunderstands that total value creation doesn't determine consumer surplus distribution—the monopolist captures all the value that previously went to consumers.
Remember: Perfect price discrimination always results in zero consumer surplus because consumers pay exactly what the product is worth to them, leaving no "consumer's bargain."
- Consider two market structures for a good with a downward-sloping demand curve and an upward-sloping marginal cost curve: a perfectly competitive market and a monopoly that can practice perfect price discrimination. From the perspective of allocative efficiency:
Answer: both markets are efficient, producing the quantity where marginal benefit equals marginal cost.
Allocative efficiency is achieved when the market produces the quantity of output where the marginal benefit to society (represented by the demand curve) equals the marginal cost of production. A perfectly competitive market achieves this because firms produce where P=MC. A perfectly price-discriminating monopolist also achieves this, as it is profitable to continue selling units as long as the price someone is willing to pay is greater than or equal to the marginal cost. Therefore, both produce the same, allocatively efficient quantity. The difference is in distribution: producer surplus is maximized under the monopoly, while consumer surplus exists in competition.
- A golf club has a single member whose demand for rounds of golf is given by P=100−2Q, where Q is the number of rounds per month. The marginal cost to the club of a round of golf is $20. To extract the entire consumer surplus from this member using a two-part tariff, what is the optimal monthly membership fee and per-round price?
Answer: Per-round price = $20, Membership fee = $1600
When a monopolist uses a two-part tariff to extract all consumer surplus, they set the per-unit price equal to marginal cost and capture the entire consumer surplus through the fixed fee. This maximizes total surplus while transferring all benefits to the firm.
First, find the optimal quantity by setting price equal to marginal cost: P=MC=20. Using the demand equation P=100−2Q, we get 20=100−2Q, so Q=40 rounds per month.
Next, calculate the consumer surplus that will become the membership fee. Consumer surplus is the triangle above the price line and below the demand curve: CS=21×base×height=21×40×(100−20)=21×40×80=1600.
Therefore, the optimal tariff is a per-round price of $20 and a monthly membership fee of $1600.
Answer A sets the per-round price at $0, which would lead to overconsumption (80 rounds) and doesn't maximize efficiency. Answer B uses a per-round price of $60, which is above marginal cost and creates deadweight loss while undercapturing consumer surplus. Answer C calculates the consumer surplus incorrectly—it uses half the actual triangle area, likely from a calculation error with the height or base.
Remember: In two-part tariff problems, always set the per-unit price equal to marginal cost first, then calculate the consumer surplus triangle to determine the optimal fixed fee. This ensures you're extracting maximum value efficiently. - A data analytics firm develops an algorithm that can predict, with high accuracy, the unique maximum price each individual visitor to an e-commerce website is willing to pay. If the e-commerce firm uses this algorithm to quote a personalized price to each visitor, it is attempting to implement a form of:
Answer: first-degree price discrimination by tailoring prices to individual valuations.
First-degree price discrimination, or perfect price discrimination, is the theoretical ideal where a firm charges each customer their exact reservation price (maximum willingness to pay). While perfect execution is impossible, using sophisticated data analysis to estimate and charge a unique price to each individual based on their predicted valuation is the closest a firm can get to implementing this strategy. It goes beyond segmenting into groups (third-degree) or basing price on quantity (second-degree).
- A monopolist producer of a patented software starts selling its product at different prices to students and businesses, whereas previously it charged a single price to all users. Which of the following statements about the welfare effects of this change to third-degree price discrimination is definitively true?
Answer: Total producer surplus will increase.
A firm will only choose to engage in price discrimination if it is profitable to do so. Therefore, producer surplus must increase (or at least not decrease). The effects on consumer surplus and total welfare (deadweight loss) are ambiguous. The higher-priced group (businesses) will lose consumer surplus, while the lower-priced group (students) will gain consumer surplus; the net effect is uncertain. Total output could increase, decrease, or stay the same, meaning the change in deadweight loss is also uncertain.
- A university bookstore sells textbooks at full price during the first month of each semester, then reduces prices by 20% in the second month, and by 40% in the third month. Students who need books immediately pay full price, while those who can wait get discounts. This strategy works because:
Answer: Students self-sort based on their time preferences and opportunity costs of delaying purchase
This is intertemporal price discrimination (a form of second-degree price discrimination) where consumers self-select based on their time preferences. Students with high opportunity costs of waiting (those who need books immediately for coursework) reveal themselves by paying full price, while price-sensitive students with lower time costs wait for discounts. The bookstore cannot directly observe these preferences but designs the pricing scheme to induce self-selection.
- A pharmaceutical company holds a patent on a new drug and sells it in two distinct markets, Country A and Country B. The price elasticity of demand for the drug is -2.0 in Country A and -4.0 in Country B. The firm's marginal cost of production is constant at $10 per unit. To maximize its total profit, what prices should the company charge in each country?
Answer: Charge $20 in Country A and $13.33 in Country B.
To maximize profit in each market, the firm should set marginal revenue (MR) equal to marginal cost (MC). The formula relating price (P), elasticity (E), and MR is MR=P(1+1/E). Setting MR = MC gives P=MC/(1+1/E).
For Country A (less elastic demand): PA=$10/(1+1/(−2.0))=$10/0.5=$20.
For Country B (more elastic demand): PB=$10/(1+1/(−4.0))=$10/0.75≈$13.33. The firm charges a higher price in the market with less elastic demand. - A local utility company faces a demand curve for electricity given by P=100−Q, where P is the price per megawatt-hour (MWh) and Q is the quantity in MWh. The marginal cost is constant at $20 per MWh. The company decides to implement a block pricing scheme, charging a price P1 for the first 20 MWh and a price P2 for any additional consumption. Among the following options, which pair of prices maximizes the utility's profit?
Answer: P1 = $80, P2 = $50
We need to calculate the profit for each option. Profit = Total Revenue - Total Cost. Total Cost = 20 * Q_total.
A) P1=$80 for first 20 MWh. At P2=$50, total demand is Q=100-50=50. So the second block is 30 MWh. Profit = (80-20)*20 + (50-20)*30 = 1200 + 900 = $2100.
B) This is a single price. Q=100-60=40. Profit = (60-20)*40 = $1600.
C) P1=$80 for first 20 MWh. At P2=$20, total demand is Q=100-20=80. Second block is 60 MWh. Profit = (80-20)*20 + (20-20)*60 = 1200 + 0 = $1200.
D) At P1=$100, Q=0. At P2=$80, Q=20. The first 20 units are sold at $80. Profit = (80-20)*20 = $1200. Option A yields the highest profit.
- A software company offers three versions of its product: Basic ($50, limited features), Professional ($150, full features), and Enterprise ($400, full features plus support). If the marginal cost of additional features is $20 and support costs $30, what pricing inefficiency does this versioning strategy primarily address?
Answer: It reduces the information asymmetry problem when the firm cannot directly observe consumer valuations
This is second-degree price discrimination (versioning) where the firm creates different product versions to induce consumer self-selection when it cannot directly observe their willingness to pay. The firm designs the product line so that high-value consumers reveal themselves by choosing higher-priced versions, solving the information asymmetry problem about consumer types.
- A theme park offers a 50% discount to local county residents. The park's management finds that profits have not increased as expected because many non-residents are having their local friends purchase tickets for them. Which condition for successful price discrimination was most significantly compromised?
Answer: The transaction costs of arbitrage were too low.
The theme park's strategy is failing due to arbitrage: the low-price group (locals) is reselling the good to the high-price group (non-residents). For price discrimination to be successful, the firm must be able to prevent this. The fact that friends can easily buy tickets for others means the cost and difficulty of conducting this arbitrage are very low. This failure to prevent resale, due to low transaction costs for arbitrage, undermines the price difference.
