You are the manager of a monopoly that sells a product to two groups of consumer

Question

You are the manager of a monopoly that sells a product to two groups of consumers in different parts of the country. Group 1’s elasticity of demand is -3, while group 2’s is -4. Your marginal cost of producing the product is $20.

a. Determine your optimal markups and prices under third-degree price discrimination. Instruction: Round your answers to two decimal places.

Markup for group 1:

Price for group 1:

Markup for group 2:

Price for group 2:

b. Which of the following are necessary conditions for third-degree price discrimination to enhance profits.

Instructions: You may select more than one answer.

We are able to prevent resale between the groups.

There are two different groups with different (and identifiable) elasticities of demand.

At least one group has elasticity of demand less than one in absolute value.

At least one group has elasticity of demand greater than 1 in absolute value.

Explanation / Answer

Answer:

Mark-up is defined as :

P – MC/P = 1/e

Where P – MC/P is the mark-up over marginal cost as a proportion of price.Mark-up over price is equal to inverse of the absolute value of the price elasticity of demand for the product. Given :

Group 1.

P-20/P =1/3

P=3P-60

2p=60

P=30

Group 2:

P-20/P =1/4

P=4P-80

3P=80

P= 26.6

Third degree price discrimination plays on the customer’s willingness to pay, which is assessed by the firm through the elasticity of demand between groups. For example:

-Rail and tube (subway) travelers can be subdivided into commuter and casual traveler

-Cinema goers can be subdivided into adults and children

-Peak and off peak use of a service is common in telecom, gas and electricity services.

Conditions necessary for Third degree Price-discrimination: (among the given options)

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