1. Consider the following Table extracted from MacManus(2007) where P represents
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Question
1. Consider the following Table extracted from MacManus(2007) where P represents the increase in price and C represents the increase in cost.
Product Line Average Price Average P- C Average P- C for the largest size of coffee
Drip Coffee $1.41 $0.22 $0.29
Regular Expresso $2.49 $0.23 $0.21
Sweet Expresso $3.04 $0.08 $0.06
According to theories of second degree price discrimination, explain why P-C is smaller (and closer to zero!) for the most expensive type of coffee (“Sweet Expresso”) while it is largest for the cheapest type of coffee (“Drip Coffee”).
Explanation / Answer
The second degree price discrimination focuses upon the decrease in prices with increasing consumption and demand. It is the reason that the lowest price coffee has highest demand and highest price coffee has lower demand in the market. Here, each coffee is the substitute for each other in the coffee segment. If prices of lowest price coffee is increased, then the consumers will not shift to the other substitutes as the other brands are already at higher price. But, if highest price coffee gets a price rise, it will cause the customers to shift to the other cheaper brands in the coffee segments.
Hence, the firms can increase the price with bigger margin when cost increases with cheaper brand (drip coffee) of coffee in terms of prices, because it is already at lowest price. But, it cannot be done by the firms when the coffee (sweet expresso) is at the highest price in the market.
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