You are the manager of a firm that sells CD players and DVD players. You work in

Question

You are the manager of a firm that sells CD players and DVD players. You work in Buffalo, New York and this is the middle of winter. So the people that live within walking distance are the only customers you might get, and there are no other stores nearby. (FedEx and UPS can't get through the snow either, so don't think about these customers shopping online). You know that there are three different types of consumers who value your two products differently, but you are unable to identify these consumers individually at the time of the sale. Assume that the firm’s costs are zero (for simplicity). Also, assume that there is one consumer of each type. However, the three types of consumers have the following valuations (reservation prices) for the two products:

a) If the firm sells the products separately, what price should it charge? How much profit will it earn? b) If the firm sells the two products as a bundle, what price should it charge? How much profit will it earn? Does bundling make sense here? c) Finally, suppose that the firm offers its consumers a choice. They can either buy the DVD player by itself for a certain price or they can buy the bundle at a different price. What price should the firm set for the DVD player by itself? For the bundle? What profit will the firm earn using this strategy?

Explanation / Answer

The monopolist can charge separate prices for each product to maximize profits. Under such a strategy, the DVD should be priced at 520, and the CD should be priced at 500. With this pricing strategy the monopolist will be able to earn 1040 from DVD sales and 500 from CD sales. A total of 1540 will be earned a profit.

If the monopolist is trying to sell the two products as a bundle the bundled price should be 520. Then the monopolist will be able to secure 3 bundles and hence he will earn a profit of 1560.

For mixed bundling the monopolist can offer a DVD at a price of 520 and a bundle at 700. Consumer type A and B will purchase a bundle while consumer type C will purchase only DVD. Monopolist will be able to earn a total profit of 1920.

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