Chap 011

Chapter 11 - Pricing Strategies for Firms with Market Power

Chapter 11Pricing Strategies for Firms with Market Power

Multiple Choice Questions

1. You are the manager of a Mom and Pop store that can buy milk from a supplier at $3.00 per gallon. If you believe the elasticity of demand for milk by customers at your store is -4, then your profit-maximizing price is A. $2.00B. $2.50C. $4.00D. $5.00

Difficulty: Medium

2. You are the manager of a gas station and your goal is to maximize profits. Based on your past experience, the elasticity of demand by Texans for a car wash is -4, while the elasticity of demand by non-Texans for a car wash is -6. If you charge Texans $20 for a car wash, how much should you charge a man with Oklahoma license plates for a car wash? A. $1.50B. $15.00C. $18.00D. $20.00

Difficulty: Hard

3. Which of the following is true for perfect competition but not true for monopolistic competition and monopoly? A. MC = MRB. P = MCC. Positive long run profitsD. P = MC and positive long run profits

Difficulty: Easy

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4. A monopoly producing a chip at a marginal cost of $6 per unit faces a demand elasticity of -2.5. Which price should it charge to optimize it profits? A. $6 per unitB. $8 per unitC. $10 per unitD. $12 per unit

Difficulty: Medium

5. A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 - Q. Which of the following is the marginal revenue function for the firm? A. MR = 60 - 2QB. MR = 50 - QC. MR = 100 - QD. MR = 50 - 2Q

Difficulty: Easy

6. A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 - Q. The monopoly price is: A. $30B. $20C. $10D. $40

Difficulty: Medium

7. A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 - Q. The demand elasticity of a widget at the monopoly price and quantity is: A. -1.5B. -2C. -2.5D. 2

Difficulty: Medium

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8. A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 - Q. What are the profits of the monopoly in equilibrium? A. $300B. $400C. $500D. $600

Difficulty: Hard

9. A monopoly produces widgets at a marginal cost of $10 per unit and zero fixed costs. It faces an inverse demand function given by P = 50 - Q. Suppose fixed costs rise to $400. What happens in the market? A. The firm will raise the priceB. The firm will shut down immediatelyC. The firm continues to produce the same output and charge the same priceD. The firm will reduce its output and raise price

Difficulty: Hard

10. Which of the following is not a condition for a firm to engage in price discrimination? A. Consumers are partitioned into two or more types, with one type having a more elastic demand than the otherB. The firm has a means of identifying consumer typesC. The consumers are assured to be sincere in telling their true naturesD. There is no resale market for the good

Difficulty: Easy

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11. Suppose P = 20 - 2Q is the market demand function for a local monopoly. The marginal cost is 2Q. The local monopoly tries to maximize its profits by equating MC = MR and charging a uniform price. What will be the equilibrium price and output? A. $6.33, 3.33 unitsB. $6.33, 5 unitsC. $13.33, 3.33 unitsD. $10, 5 units

Difficulty: Easy

12. Suppose P = 20 - 2Q is the market demand function for a local monopoly. The marginal cost is 2Q. The firm currently uses a standard pricing strategy. Which of the following will allow the firm to enhance the profits? A. Engage in two-part pricingB. Engage in commodity bundlingC. Engage in randomized pricingD. Engage in two-part pricing and engage in commodity bundling

Difficulty: Medium

13. Suppose P = 20 - 2Q is the market demand function for a local monopoly. The marginal cost is 2Q. If fixed costs are zero and the firm engages in two-part pricing, the most profits the firm will earn is: A. $5B. $10C. $25D. $50

Difficulty: Hard

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14. Cinemas sometimes give senior citizens discounts. What is the possible privately motivated purpose for them to do so? A. Purely because entrepreneurs are benevolentB. Senior citizens have a more elastic demand for movies than ordinary citizensC. Senior citizens lack recreational activitiesD. None of the statements associated with this question are correct

Difficulty: Medium

15. Which of the following pricing strategies does not usually enhance the profits of firms with market power? A. Price matchingB. Cross-subsidiesC. Two-part pricingD. Marginal cost pricing

Difficulty: Medium

16. Which of the following statements is true? A. The more elastic the demand, the higher is the profit-maximizing markupB. The more elastic the demand, the lower is the profit-maximizing markupC. The higher the marginal cost, the lower the profit-maximizing priceD. The higher the average cost, the lower the profit-maximizing price

Difficulty: Easy

17. In a Cournot oligopoly with N-firms and identical marginal costs, the relationship between the price elasticity of market demand and that of the firm is: A. EM = EF

B. EM = NEF

C. EM = EF/ND. No deterministic relationship

Difficulty: Easy

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18. A new firm successfully enters a three-firm Cournot oligopoly without changing the demand and cost structures. The new price becomes: A. 75 percent of the original priceB. 50 percent of the original priceC. The same as the original priceD. Unknown for lack of other information

Difficulty: Hard

19. The idea of charging two different groups of consumers two different prices is practiced in: A. Price discriminationB. Two-part pricingC. Price matchingD. None of the statements associated with this question are correct

Difficulty: Easy

20. One of the conditions under which price discrimination is profitable is: A. Ability to identify consumer typesB. Inability to resell the goodC. Differences in demand elasticitiesD. All of the statements associated with this question are correct

Difficulty: Easy

21. During spring break, students have an elasticity of demand for a trip to Florida of -3. How much should an airline charge students for a ticket if the price it charges the general public is $360? Assume the general public have an elasticity of -2. A. $240B. $250C. $260D. $270

Difficulty: Medium

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22. A local video store estimates their average customer's demand per year is Q = 7 - 2P, and knows the marginal cost of each rental is $0.5. How much should the store charge for an annual membership in order to extract the entire consumer surplus via an optimal two-part pricing strategy? A. $9B. $10C. $11D. $12

Difficulty: Hard

23. A local video store estimates their average customer's demand per year is Q = 7 - 2P, and knows the marginal cost of each rental is $0.5. How much should the store charge for each rental if it engages in optimal two-part pricing? A. $0.35B. $0.5C. $0.7D. $1.0

Difficulty: Easy

24. A local video store estimates their average customer's demand per year is Q = 7 - 2P, and knows the marginal cost of each rental is $0.5. What is the annual profit that the video store expects to make on an average customer if it engages in optimal two-part pricing? A. $6B. $7C. $8D. $9

Difficulty: Hard

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25. If your demand for renting videos is Q = 5 - 2P, should you purchase the annual membership from a video store that charges $0.5 per rental, plus an annual membership fee of $12? A. Definitely yesB. Definitely noC. Probably yesD. Cannot be decided

Difficulty: Hard

26. What price should a firm charge for a package of two shirts given a marginal cost of $2 and an inverse demand function P = 6 - 2Q by the representative consumer? A. $2B. $6C. $8D. $10

Difficulty: Hard

27. A Broadway theater sells weekday show tickets at a lower price than for a weekend show. This is an example of: A. Price discriminationB. Peak-load pricingC. Price discrimination or peak-load pricingD. None of the statements associated with this question are correct

Difficulty: Medium

28. A campus auditorium sells tickets at half price to students during the last 30-minutes before a concert starts. This is an example of: A. Price discriminationB. Peak-load pricingC. Price discrimination or peak-load pricingD. None of the statements associated with this question are correct

Difficulty: Medium

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29. A necessary cost-side condition for a firm to implement a cross subsidization pricing strategy is: A. Economies of scaleB. Economies of scopeC. Constant marginal costD. Limited capacity

Difficulty: Easy

30. The special cost structure that is necessary for a firm to adopt a peak-load pricing policy is? A. Economies of scaleB. Economies of scopeC. Constant marginal costD. Limited capacity

Difficulty: Easy

31. The special demand structure that induces a firm to use a cross subsidization strategy is: A. Perfect substitution among productsB. Imperfect substitution among productsC. Independent demand for productsD. Interdependent demand for products

Difficulty: Easy

32. Snowpeak Ski Resort offers a price for a lift ticket that is barely over its marginal cost, but the high equipment rental fee keeps generating big profits. Which pricing strategy is the management using? A. Price discriminationB. Two-part pricingC. Commodity bundlingD. Cross subsidization

Difficulty: Easy

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33. Which of the following strategies will most likely not enhance profits in a Bertrand oligopoly? A. Two-part pricingB. Price matchingC. Randomized pricingD. Brand loyalty

Difficulty: Medium

34. Firms that use a price matching strategy attempt to keep price at: A. Marginal costB. The oligopoly priceC. The monopoly priceD. The oligopoly price or the monopoly price

Difficulty: Medium

35. Price matching strategies may fail to enhance profits when: A. Firms cannot prevent customer's from deceptive claimsB. Firms have different marginal costsC. Firms cannot prevent customer"s from deceptive claims or firms have different marginal costsD. None of the statements associated with this question are correct

Difficulty: Medium

36. Which of the following statements about a price matching strategy is incorrect? A. It may be applied in situations besides Bertrand oligopolyB. It requires that the firms can monitor their rival's pricesC. It reduces the incentive for a rival firm to initiate a price warD. It only guarantees to match prices that are advertised publicly

Difficulty: Hard

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37. Which of the following pricing policies compensate customers if the firm fails to provide the best price in the market? A. Price matchingB. Beat-or-payC. Brand loyaltyD. Randomized pricing

Difficulty: Easy

38. Which group of policies aims at discouraging rivals to enter a price war? A. Price matching, beat-or-pay, and randomized pricingB. Price matching, brand loyalty, and commodity bundlingC. Randomized pricing, price discrimination, and cross subsidizationD. Load-peak pricing, two-part pricing, and price matching

Difficulty: Medium

39. Which group of policies aims at extracting all consumer surplus? A. Price discrimination and peak load pricingB. Cross subsidization and brand loyaltyC. Price matching and randomized pricingD. Two-part pricing and commodity bundling

Difficulty: Medium

40. Brand loyalty can be enhanced through: A. An advertising campaignB. A price warC. Neither an advertising campaign nor a price warD. An advertising campaign and a price war

Difficulty: Easy

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41. If a product is perceived by consumers as homogeneous, which of the following strategies will work to induce brand loyalty? A. Intensive advertising campaignB. Price wars with competitorsC. Frequent buyer rebate programsD. None of the statements associated with this question are correct

Difficulty: Easy

42. The purpose of randomized pricing is to reduce: A. Consumer price information onlyB. Competitor price information onlyC. Both customer and competitor information about priceD. The firm's pricing inflexibility

Difficulty: Medium

43. If a monopolist claims his profit-maximizing markup factor is 3, what is the corresponding price elasticity of demand? A. -1.5B. -2.0C. -2.5D. -3.0

Difficulty: Medium

44. If the profit-maximizing markup factor in a 3-firm Cournot oligopoly is -2, what is the corresponding market elasticity of demand? A. -1/2B. -2/3C. -1.0D. -2.0

Difficulty: Hard

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45. A firm with market power has an individual consumer demand of Q = 20 - 4P and costs of C = 4Q. What is the optimal amount of this product to package in a single block? A. 2B. 3C. 4D. 5

Difficulty: Hard

46. A firm with market power has an individual consumer demand of Q = 20 - 4P and costs of C = 4Q. What is optimal price to charge for a block of 20 units? A. $18B. $36C. $72D. $90

Difficulty: Medium

47. A firm has capacity limitations and charges $30 for their service during daily peak times. If the market demand elasticity drops from -3 during peak times to -5 at off peak times, how much should the firm charge to earn the maximum profit during off peak times? A. $20B. $21C. $24D. Not enough information to determine

Difficulty: Medium

48. Which of the following pricing policies enhances profits by creating brand-loyal consumers? A. Frequent flyer programsB. Beat-or-pay strategiesC. Trigger strategiesD. Frequent flyer programs and beat-or-pay strategies

Difficulty: Easy

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49. Suppose two types of consumers buy suits. Consumers of type A will pay $100 for a coat, and $50 for pants. Consumers of type B will pay $75 for a coat, and $75 for pants. The firm selling suits faces no competition and has a marginal cost of zero. If the firm can identify each consumer type and can price discriminate, what is the optimal price for a pair of pants? A. Charge both types $150B. Charge both types $75C. Charge type A consumers $50, and type B consumers $75D. Charge type A consumers $50, and type B consumers $50

Difficulty: Medium

50. A monopolist claims his profit-maximizing markup factor is 10. What is the price elasticity of demand for the firm's product? A. -1.5B. -2.0C. -2.5D. None of the statements associated with this question are correct

Difficulty: Medium

51. If the profit-maximizing markup factor in a 10-firm Cournot oligopoly is -2, what is the corresponding market elasticity of demand? A. -1.0B. -1.2C. -2.0D. None of the statements associated with this question are correct

Difficulty: Hard

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52. The average consumer at a firm with market power has an inverse demand function of P = 10 - Q. The firm's cost function is C = 2Q. If the firm engages in two part pricing, what is the optimal fixed fee to charge each consumer? A. $2B. $32C. $64D. None of the statements associated with this question are correct

Difficulty: Medium

53. The average consumer at a firm with market power has an inverse demand function of P = 10 - Q. The firm's cost function is C = 2Q. If the firm engages in two-part pricing, what is the optimal price to charge a consumer for each unit purchased? A. $0B. $1C. $4D. None of the statements associated with this question are correct

Difficulty: Medium

54. The average consumer at a firm with market power has an inverse demand function of P = 10 - Q. The firm's cost function is C = 2Q. If the firm engages in optimal two-part pricing, it will earn profits of A. $2B. $32C. $64D. None of the statements associated with this question are correct

Difficulty: Medium

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55. Suppose two types of consumers buy suits. Consumers of type A will pay $100 for a coat, and $50 for pants. Consumers of type B will pay $75 for a coat, and $75 for pants. The firm selling suits faces no competition and has a marginal cost of zero. If the firm charges $100 for a suit (which includes both pants and a coat), the firm will sell a suit to: A. Type A consumersB. Type B consumersC. Type A consumers and type B consumersD. None of the statements associated with this question are correct

Difficulty: Medium

56. Suppose two types of consumers buy suits. Consumers of type A will pay $100 for a coat, and $50 for pants. Consumers of type B will pay $75 for a coat, and $75 for pants. The firm selling suits faces no competition and has a marginal cost of zero. If the firm charges $75 for pants and $75 for a coat, the firm will sell a coat to: A. Type A consumersB. Type B consumersC. Type A consumers and type B consumersD. None of the statements associated with this question are correct

Difficulty: Medium

57. Suppose two types of consumers buy suits. Consumers of type A will pay $100 for a coat, and $50 for pants. Consumers of type B will pay $75 for a coat, and $75 for pants. The firm selling suits faces no competition and has a marginal cost of zero. If the firm sells coats and pants for $25 each, but offers a bundle containing both a coat and pants for $150, how many bundles will the firm sell? A. 0B. 1C. 2D. Insufficient information

Difficulty: Medium

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58. Suppose two types of consumers buy suits. Consumers of type A will pay $100 for a coat, and $50 for pants. Consumers of type B will pay $75 for a coat, and $75 for pants. The firm selling suits faces no competition and has a marginal cost of zero. The optimal commodity bundling strategy is: A. Charge $150 for a suitB. Charge $75 for a suitC. Charge $100 for a suitD. Charge $125 for a suit

Difficulty: Medium

59. When two or more divisions mark up prices in excess of marginal cost, A. Double marginalization occursB. Two-part pricing occursC. Second-degree price discrimination occursD. None of the statements associated with this question are correct

Difficulty: Easy

60. To circumvent the problem of double marginalization: A. Transfer prices must be set that maximize the overall value of the firm rather than the profits of the upstream divisionB. Firms should engage in two-part pricing, unless it is possible to engage in either first or second degree price discriminationC. Firms should vertically integrateD. None of the statements associated with this question are correct

Difficulty: Medium

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61. First-degree price discrimination A. Occurs when a firm charges each consumer the maximum price he or she would be willing to pay for each unit of the good purchasedB. Results in the firm extracting all surplus from consumersC. Occurs when a firm charges each consumer the maximum price he or she would be willing to pay for each unit of the good purchased and results in the firm extracting all surplus from consumersD. None of the statements associated with this question are correct

Difficulty: Easy

62. Second-degree price discrimination A. Is the practice of posting a discrete schedule of declining prices for different ranges of quantitiesB. Eliminates the problem of double marginalizationC. Results in transfer pricingD. None of the statements associated with this question are correct

Difficulty: Easy

63. You are the manager of a Mom and Pop store that can buy milk from a supplier at $2.00 per gallon. If you believe the elasticity of demand for milk by customers at your store is -3, then your profit-maximizing price is A. $1.33B. $2.75C. $3.00D. $4.50

Difficulty: Easy

Use the following information for questions 64-66.A monopoly produces widgets at a marginal cost of $8 per unit and zero fixed costs. It faces an inverse demand function given by P = 38 - Q.

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64. The monopoly price is: A. $30B. $23C. $15D. $8

Difficulty: Easy

65. What are the profits of the monopoly in equilibrium? A. $225B. $120C. $345D. None of the statements associated with this question are correct

Difficulty: Easy

66. Suppose fixed costs rise to $200. What will happen in the market? A. The firm will decrease its output and lower its priceB. The firm will increase the priceC. The firm will shut down immediatelyD. The firm continues to produce the same output and charge the same price

Difficulty: Medium

67. Which of the following pricing strategies does not usually enhance the profits of firms with market power? A. Marginal cost pricingB. Price discriminationC. Block pricingD. Commodity bundling

Difficulty: Easy

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68. Which of the following is a correct statement? A. The lower the marginal cost, the higher the profit-maximizing priceB. The lower the average cost, the higher the profit-maximizing priceC. The more inelastic the demand, the higher is the profit-maximizing markupD. The more elastic the demand, the higher is the profit-maximizing markup

Difficulty: Hard

69. The idea of charging two different groups of consumers two different prices is practiced in: A. Two-part pricingB. Price matchingC. Commodity bundlingD. None of the statements associated with this question are correct

Difficulty: Easy

70. During spring break, students have an elasticity of demand for a trip to Cancun, Mexico of -4. How much should an airline charge students for a ticket if the price it charges the general public is $420? Assume the general public has an elasticity of -2. A. $210B. $280C. $160D. $105

Difficulty: Hard

71. A local video store estimates their average customer's demand per year is Q = 20 - 4P, and knows the marginal cost of each rental is $1.00. How much should the store charge for an annual membership in order to extract the entire consumer surplus via an optimal two-part pricing strategy? A. $20B. $32C. $40D. $64

Difficulty: Medium

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72. What price should a firm charge for a package of two shirts given a marginal cost of $4 and an inverse demand function P = 8 - 2Q by the representative consumer? A. $4B. $8C. $12D. $16

Difficulty: Easy

73. Which of the following pricing policies does not extract the entire consumer surplus from the market? A. First-degree price discriminationB. Peak load pricingC. Two-part pricingD. Block pricing

Difficulty: Easy

74. Firms will often implement randomized pricing in an attempt to reduce A. Only competitor price informationB. Only consumer price informationC. Both customer and competitor information about priceD. Randomized pricing does not affect information available to consumers or competitors

Difficulty: Medium

75. To avoid the problem of double marginalization A. Transfer prices must be set that maximize the overall value of the firm rather than the profits of the upstream divisionB. Firms should put more emphasis on vertical integrationC. Firms should engage in two-part pricingD. Firms should engage in commodity bundling, unless it is possible to engage in either first or second degree price discrimination

Difficulty: Medium

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76. In a Cournot oligopoly with N-firms and identical marginal costs, the relationship between the price elasticity of demand for the form and that of the market is A. EF = EM

B. EF = NEM

C. EF = EM/ND. EF = N/EM

Difficulty: Easy

77. Which of the following is a true statement about the process of cross-subsidization, given a firm is selling two products? A. The two products can not have interdependent demand functionsB. The firm will sell both of its products at prices set above costsC. The firm needs cost complementarities in the production of the two goodsD. The firm will sell both of its products at prices set above costs and the firm needs cost complementarities in the production of the two goods

Difficulty: Medium

78. Which of the following statements is true regarding a simple pricing rule for monopoly and monopolistic competition? A. P[EF / (1 + EF)] = MCB. P = [(1 + EF) / EF]MCC. P[(1 + EF) / EF] = MCD. All of the statements associated with this question are correct

Difficulty: Easy

79. Which of the following statements is true regarding profit-maximizing markup for a Cournot oligopoly with N identical firms? A. P[NEF / (1 + NEF)] = MCB. P = [(1 + NEF) / NEF]MCC. P[N(1 + EF) / NEF] = MCD. P = [NEF / (1 + NEF)]MC

Difficulty: Easy

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80. Which of the following is true regarding the relationship between the elasticity of demand for an individual firm and the elasticity of demand for the market in a Cournot oligopoly with 5 identical firms? A. EF = (df(p) / dP) (5P / Q)B. EF = (df(p) / dP) (5Q / P)C. EM = 5EF

D. EF = (1/5)EM

Difficulty: Hard

81. Suppose you compete in a Cournot oligopoly market consisting of 6 firms. The equilibrium market price and quantity are $5 and 10 units, respectively. The marginal cost for each firm is $3. Based on this information we know the price elasticity of demand is A. -0.417B. 0.167C. -2.4D. There is insufficient information to answer this question

Difficulty: Hard

82. Suppose that the demand for a monopolist's product is estimated to be Qd = 100 - 2P and it's total costs are C(Q) = 10Q. Under first-degree price discrimination the optimal price(s), number of total units exchanged, profit and consumer surplus are A. P = $30; Q = 40, = $800; CS = $400B. 10 P 100; Q = 80; = $1600; CS = $1600C. 10 P 50; Q = 80, = $1600; CS = $0D. P =$30; Q = 40, = $600; CS = $0

Difficulty: Medium

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83. To engage in first-degree price discrimination a firm must A. Be able to set P > MCB. Know each consumer's maximum willingness to payC. Prevent low-value consumers from reselling to high-value consumersD. All of the statements associated with this question are correct

Difficulty: Medium

Answer question 84 based on the following information:

84. The above table contains different consumers' values for three software titles: PowerPoint, Excel and Word. Suppose there are 100 consumers of each type. It costs Microsoft $5 to produce each piece of software. If Microsoft wants to devise a pricing strategy that is incentive compatible between consumer types and will maximize its profit, then it should A. Charge $50 for PowerPoint, $80 for Excel and $75 for WordB. Charge a single price of $250 for the bundle of PowerPoint, Excel and WordC. Charge $125 for PowerPoint, $175 for Excel and $150 for WordD. Charge $325 for the bundle of PowerPoint, Excel and Word and permit consumers to purchase each software title individually at $81.10 each

Difficulty: Hard

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85. Suppose you are an analyst for the Coca-Cola Company. An individuals' inverse demand for Coca-Cola is estimated to be P = 98 - 4Q (in cents). If Coca-Cola is produced according to the following cost function C(Q) = 1,000 + 2Q (in cents), compute the optimal price and the number of cans to sell as a single package. A. $1200 per package and 12 cansB. $12 per package and 24 cansC. $11.52 per package and 12 cansD. $15 per package and 16.67 cans

Difficulty: Hard

86. Suppose you are an analyst for the Coca-Cola Company. An individuals' inverse demand for Coca-Cola is estimated to be P = 98 - 4Q (in cents). If Coca-Cola is produced according to the following cost function C(Q) = 1,000 + 2Q (in cents), compute the surplus consumer receive when Coca-Cola charges the optimal block price. A. $0B. $11.52C. $1152D. $576

Difficulty: Medium

87. Suppose that VerizonWireless has hired you as a consultant to determine what price it should set for calling services. Suppose that an individuals' inverse demand for wireless services in the greater Boston area is estimated to be P = 100 - 33Q and the marginal cost of providing wireless services to the area is $1 per minute. What is the optimal two-part price that you would suggest to Verizon? A. Charge a fixed fee = $95.5 and a usage fee of $1 per minuteB. Charge a fixed fee = $3 and a usage fee of $0.33 per minuteC. Charge a fixed fee = $148.50 and a usage fee of $1 per minuteD. Charge a fixed fee = $3 and a usage fee of $3 per minute

Difficulty: Medium

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88. Suppose that VerizonWireless has hired you as a consultant to determine what price it should set for calling services. Suppose that an individuals' inverse demand for wireless services in the greater Boston area is estimated to be P = 100 - 33Q and the marginal cost of providing wireless services to the area is $1 per minute. Compute consumer surplus when VerizonWireless charges an optimal two-part price. A. $0B. $74.25C. $148.50D. There is insufficient information to compute consumer surplus

Difficulty: Medium

89. Suppose that the inverse demand for a downstream firm is by P = 150 - Q. Its upstream division produces a critical input with costs of CU(Qd) = 5(Qd)2. The downstream firm's cost is Cd(Q) = 10Q. When there is no external market for the downstream firm's critical input, the marginal revenue for the downstream firm is A. MRd(Q) = 150 - 2QB. MRd(Q) = 150 - QC. MRd(Q) = 140 - 2QD. MRd(Q) = 140 - Q

Difficulty: Easy

90. Suppose that the inverse demand for a downstream firm is by P = 150 - Q. Its upstream division produces a critical input with costs of CU(Qd) = 5(Qd)2. The downstream firm's cost is Cd(Q) = 10Q. When there is no external market for the downstream firm's critical input, the net marginal revenue for the downstream firm is A. NMRd = 140 - 2QB. NMRd = 150 - 2QC. NMRd = 140 - QD. NMRd = 150 - Q

Difficulty: Medium

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91. Suppose that the inverse demand for a downstream firm is by P = 150-Q. Its upstream division produces a critical input with costs of CU(Qd) = 5(Qd)2. The downstream firm's cost is Cd(Q) = 10Q. When there is no external market for the downstream firm's critical input, the downstream firm should produce A. 11.67 unitsB. 12.5 unitsC. 14 unitsD. 15 units

Difficulty: Hard

92. The price elasticity of demand for senior citizens purchasing coffee from McDonald's is -5 while non senior citizens have a price elasticity of demand equal to -1.25. If is cost McDonald's $0.02 to produce a coffee, the optimal price for a cup of coffee for senior citizens and resultant marginal cost under third-degree price discrimination are, respectively, A. $0.016 and $0.20B. $0.02 and $0.80C. $0.025 and $0.02D. $0.10 and $0.02

Difficulty: Medium

93. The price elasticity of demand for senior citizens purchasing coffee from McDonald's is -5 while non senior citizens have a price elasticity of demand equal to -1.25. If is cost McDonald's $0.02 to produce a coffee, the optimal price for a cup of coffee for non senior citizens and resultant marginal cost under third-degree price discrimination are A. $0.004 and $0.02B. $0.02 and $0.80C. $0.10 and $0.02D. $10 and $0.20

Difficulty: Medium

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Essay Questions

94. A local dentist read an article published by the American Dental Association estimating that the elasticity of demand for the representative dentist's services is -2.5. How much should the dentist mark up her price over marginal cost?

P = [EF/(1+EF)]MC = [2.5/1.5] = 1.67MC.

95. You are a truck farmer and bring produce to a farmer's market every Wednesday. You have found that on a typical day five other farmers bring their produce to market. Years of experience have taught you that you make the most money by pricing your produce at 1.15 times your marginal cost. What is your elasticity of demand in this Cournot oligopoly? What it the market elasticity of demand?

Since, in Cournot oligopoly, P = [NEM/(1 + NEM)]MC, and N = 6, it follows that

Thus the market elasticity of demand is -1.277. Your elasticity of demand is six times the market elasticity, or -7.662.

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96. You are the only pharmacist in a small town; the next closest drugstore is 50 miles away. The population in your town consists of young farmers and older retired families. You have noticed that the young farmers are less sensitive to price changes than the retired population. Specifically, you have found that the working population has an own price elasticity of demand of -2 and the retired farmers have an own price elasticity of -4. How can you use this information to your advantage?

Since the two groups of people have different demand elasticity for drugs, you should charge them different prices for the same drugs to maximize profits. For the working population, which has -2 as demand elasticity, you should follow the rule

That is, you should charge young farmers a price that is 2 times your marginal cost.For the retired population,

so you should charge them a price that is 1.33 times marginal cost.

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97. You have just been hired as manager of a new health spa in Retirement Village, Florida. The owner has commissioned a market study that estimates the average customer's monthly

demand curve for visiting the health spa to be . The cost of operating is

, where Q is the number of visits. The owner has been charging a $20 per-month membership fee and a $5 per-visit fee. Part of your salary is 10 percent of the monthly profits. Suggest a pricing strategy that will increase your salary?

With the original pricing scheme, the number of visits per customer is

. Hence, profit from each customer is $20 + ($5 - $3)(48.75) = $117.5, and the compensation to the manager is 10% of $117.5, or $11.75 per customer. However, you may charge a price of $3 (equal to marginal cost) and charge a membership fee equaling the consumer's surplus. This gives the number of visits per customer equal to

The consumer surplus is .5($200 - $3)(49.25) = $4,851.13. Hence, the membership fee should be as high as $4,851.13 per person. Your compensation will be .10($4,851.13) = $485.11 per customer.

98. Suppose a typical consumer's inverse demand function for bottled water at a resort area

where one firm owns all the rights to a local spring is given by . The marginal cost for gathering and bottling the water is $3 per gallon. Find the optimal number of bottles to package together for sale and the profit-maximizing price to charge for the package. Show the solution graphically?

Each package should contain four bottles while the price for each package is $36. With this pricing scheme, you capture a net profit $24, which is the shaded area in Figure 11-5.Figure 11-5

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99. As manager of the only video store in town, you have noticed that on Thursday through Sunday the demand for renting your movies is much higher than it is on Monday through Wednesday. You therefore conducted a study that revealed two different market demand

curves. On weekends, your inverse demand curve is ; on weekdays, it is

. The marginal cost of renting a movie is $.50 (50 cents). Your average customer never rents more than one movie at a time. What pricing strategy will maximize your profits?

This manager can maximize profits by engaging in two part pricing. Since demand differs on weekends and weekdays, the manager can adopt two different schemes. On weekends, the market inverse demand function is P = 10 - .001Q. Since marginal cost is $0.5, setting P = MC leads to a total 9,500 videos sold on the weekend. Total consumer surplus in the market is .5(10 - .5)(9500) = $45,125, or $4.75 for each of the 9500 customers. The optimal policy, therefore, is to charge a fixed fee of $4.75 to enter the store on a weekend, and then rent videos at the bargain price of $0.50 each once a consumer enters the store. Since the average consumer buys one video, this amounts to a price of $5.25 per video.A similar analysis reveals that, on weekdays, the entry fee should be $2.25, with videos still priced at $0.50 each (which amounts to $2.75 per video if each consumer buys exactly one).

100. During the 1990s, several airlines were on the brink of bankruptcy. These same airlines were giving away millions of dollars in free airline travel through their frequent-flyer programs. Do you think it would have been a good idea for these airlines to eliminate their frequent-flyer programs in order to earn higher profits? Explain.

It would probably not be a good idea for an airline to unilaterally eliminate its frequent flyer program. First, the airline would probably lose customers to other airlines that offered the program. Secondly, frequent flyer programs allow firms to avoid some of the pitfalls of Bertrand competition by creating brand loyalty and hence some degree of product differentiation. Eliminating the programs would probably result in fewer customers and lower prices, which would harm the airlines since much of their costs are fixed.

101. Many restaurants have found that it is advantageous to offer free appetizers with a two-drink minimum during a limited number of hours. Is this profit-maximizing behavior? Why or why not?

Yes, it probably is. This is a case of cross-subsidization. The appetizers are typically quite salty, leading customers to buy more drinks than would otherwise be the case.

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102. You run a golf course at a tourist resort. At your resort, there are two distinct groups of players. One group owns property at the resort and resides there most of the year. On average,

each of these consumers has a monthly inverse demand for golf services of . The other group visits for one week at a time and has a total weekly demand curve of

. What pricing strategy will maximize your profits?

Suppose the marginal cost to the golf course of each visit is zero. The most a customer is willing to pay is his or her total valuation of the quantity of goods consumed. The total valuation is measured by the area under the inverse demand curve and the horizontal axis for that range of quantity. Hence, the most a property owner is willing to pay is .5($100)(200) = $10,000 per month. The most a tourist is willing to pay is .5($40)(400) = $8,000 per week. Hence, your optimal pricing policy is: charge property owners a membership fee of $10,000 per month per person; charge tourists a membership fee of $8,000 per week per person. And then let each golfer play golf for free.

103. An auto dealer in Chicago recently told his mother that he makes no money on the sales of his cars but the markup on accessories is 200 percent. Can this possibly be a profit-maximizing strategy? Explain.

Perhaps. By charging a low price for the "base car" but optimally pricing a bundle of options, the dealer may be able to earn higher profits than by attempting to make a profit on each individual item separately.

104. One year, Chrysler offered rebates on almost all of its cars. In May of that year it announced that the rebate program would end on June 30. It also announced that no further rebates would be offered for the rest of the year. Chrysler guaranteed this by promising that if it did offer any rebates larger than those offered between May 1 and June 30, all customers who purchased cars before the new rebate would get the full rebate. How should this announcement have affected the pricing behavior of other car manufacturers?

Since Chrysler's offer should be considered as credible, other car manufacturers should recognize it as a commitment of charging a relatively high price for the remainder of 1990. Rivals could offer rebates, without fear that Chrysler would follow by matching their rebates.

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105. In most cities all lumber yards advertise that they have the lowest price in town. In addition, they often claim that they will match the prices of any other lumber yards. Is this Bertrand competition that brings about zero economic profits? Explain.

No; it actually leads to higher prices. No firm has an incentive to offer lower prices, since doing so will not attract additional customers (the other firm will match the lower price.)

106. Grocery stores make most of their profits on soft drinks, beer, chips, and candy. A casual look at prices of these items reveals that these prices change extremely often and can vary as much as 50 percent. Is this because the wholesale price of these items fluctuates this dramatically, or is there some other possible explanation?

The frequent variation in prices on soft drinks, beer, chips and candy is not due to the fluctuation in the wholesale price of these items. It is because grocery stores' managers are engaging in randomized pricing, in an attempt to keep their rivals from being able to know what price to charge to steal their customers.

107. You are the owner of a mom-and-pop store that buys milk from a supplier at a cost of $1 per gallon. If you estimate the elasticity of demand for milk sold at your store to be -3.5, what are your profit-maximizing markup and price?

P = [EF/(1 + EF)]MC = 1.4MC. Thus, your price should be 1.4 times marginal cost, or $1.40 per gallon.

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108. You are the manager of a gas station in a small town, and your goal is to maximize profits. Based on your experience, the elasticity of demand of Texans for a car wash is -2, while that of non-Texans is -1.5. Your marginal cost is $6.a. Are the conditions necessary for price discrimination to be an effective means of enhancing profits being met? Explain.b. What is the profit-maximizing price to charge a Texan for a car wash?c. What is the profit-maximizing price to charge a Californian for a car wash?

a. Price discrimination can be implemented because you can identify the nature of the driver by noticing the issuing state of the vehicle plate.b. Price for Texans:

c. Price for Californians:

109. An industry produces 10,000 units of output at a price of $100. At the equilibrium price and quantity, the market elasticity of demand is -0.75. Does this industry consist of a profit-maximizing monopolist? Explain.

The industry cannot be comprised of a price-setting profit-maximizing monopolist because such a firm will not produce in the inelastic part of the demand curve. It can increase its profit by lowering output whenever demand is inelastic.

110. A monopolist is profit maximizing where the elasticity of demand is -2 and price is $4. What is the monopolist's marginal cost?

Using the relation P = [EF/(1 + EF)]MC, it follows that MC = $2.

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111. Most wholesalers post a "suggested retail price" on packages, which in turn are sold by retailers. Is there an economic basis for the suggested retail price? As the manager of a retailing outlet, what factors will determine whether you should charge the suggested retail price or some higher or lower price?

The suggested retail price is the price that maximizes the wholesaler's profit in the national market based on the national elasticity of demand for the product. A local firm should charge a lower price if the local demand is more elastic than the national average and a higher price if the local demand is more inelastic than the national average.

112. Before the breakup of AT&T, the firm charged a price for local telephone services that was roughly one-half of its cost of providing the services. In contrast, it charged almost two times it cost for long distance services. Why do you think AT&T adopted this pricing strategy?

Cross subsidization. First, there are some economies of scope in providing telephone services, which means that it is cheaper to produce local and long-distance services together than separately. Moreover, there is interdependence in demand. In order to place a long-distance call, one needs local access to a phone line. By charging a low price for local services, more people purchase phones than would have otherwise been the case. This led to an increase in the number of people that could be called with AT&T's long-distance services (since more phones were used across the nation), and greater long-distance usage than would otherwise have been the case. Thus, by cross subsidizing local services with long distance services, AT&T was able to earn higher profits than it otherwise would have earned.

113. Three consumers who want to buy a new car have the following valuations for dealer options:

Assuming costs are zero, how much would the dealer make if it priced power brakes at $800, priced air conditioners at $200, and sold the bundle for $1,300?

No consumer will buy a bundle at this price, since it would be cheaper to purchase the items separately. The firm would sell consumer 3 a set of power brakes for $800, and an air conditioner to consumers 1 and 2 at $200 each. Total firm profits are thus $1,200.

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114. You are the CEO of Comchip, a firm that sells specialized computers. Each of the firm's computers contain a unique chip that is produced at Comchip's west coast plant at a cost of

. Once produced, the chips are shipped exclusively to the firm's east coast plant. There, the computers are assembled, boxed, and shipped to the market at a cost of

. An economic consultant recently estimated the demand for Comchip's

computers and found it to be . Determine Comchip's optimal output and price for computers, and explain how it can induce plant managers to produce the required number of chips and computers.

Since Qc = Q, the number of chips that maximizes overall firm profits is determined by setting the NMRw = MCw:NMRw = 5,000 - 2Qc - 200 = 2Qc.Solving for Qc, the west-coast plant should produce Qc = 1,200 chips, and (since Q = Qc) the east coast plant should produce 1,200 computers. The optimal price for the firm's computers, therefore, is P = 5,000 - 1,200 = $3,800. The firm can achieve this outcome by setting the optimal transfer price at the west coast plant's marginal cost of producing 1,200 chips, or PT = $2,400, and by then providing east and west coast managers an incentive to maximize their plant's profits given this transfer price.

115. You are the manager of We Trust-the only bank in a small town. Your boss has been studying a report on transaction volume and has noticed a troubling trend: We Trust does not have enough tellers to handle the bank's maximum capacity, which occurs during the lunch hour. Your boss has asked for a short report that summarizes alternative plans for solving this problem, the pros and cons of each plan, and your recommended course of action. Provide this report.

One option would be to hire more tellers, but this would increase the firm's cost. Another option would be to engage in peak-load pricing by charging a fee to customers who use tellers during the noon hour, but this could create bad will. Yet another option would be to provide customers an incentive to use ATM machines. This could be accomplished by setting fees on ATM use that are lower than those charged to customers who use standard tellers.

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116. Suppose that JVC is trying to decide how to price a new stereo system composed of a receiver, CD player, and speakers. The company's economists have estimated that two different groups will purchase these products: students and club owners. The economists' analysis suggests that the total market for its brand of stereos consists of 10,000 students and 50,000 club owners. In addition, it is estimated that the maximum amount each group will pay for each stereo component is as follows:

JVC's objective is to maximize revenues, and it is considering three strategies to price its stereo components: (1) a standard strategy whereby it prices each stereo component separately; (2) perfect price discrimination; or (3) bundling the three components together and selling only bundles containing the receiver, CD player, and speakers.a. If JVC uses a standard pricing strategy, what price should it charge for the receiver, for the CD player, and for the speakers to maximize revenues? What are the revenues they will earn through this strategy?b. Suppose JVC adopts a first-degree price discrimination policy. What prices should it charge to maximize revenues? What are JVC's revenues using this strategy?c. Suppose that JVC markets the receiver, CD player, and speakers together. That is, it uses a commodity-bundle strategy such that the products are sold as one item. What price should JVC charge to maximize revenues? How much will it earn?

a. Price receivers at $200, CD players at $75, and speakers at $250. Revenues from receiver sales will thus be $200(60,000) = $12 million, revenues from CD player sales will be $75(0,000) = $4.5 million, and speaker sales will be $250(50,000) = $12.5 million.b. Charge each group the maximum price they will pay for each item. Students will pay $250, $150, and $100 for a receiver, CD player, and Speakers, respectively. Club owners will pay $200, $75, and $250, respectively. Total revenues from this strategy are: $5 million + $26.25 million = $31.25 million.c.Using a commodity bundling strategy, JVC would maximize revenues when it charges $500 for a bundle containing all three components. Its' revenue would be $30 million (60,000 $500).

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