ME Problem Set VII

PGP 2016-18

1. Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to
$20,000 and a fixed cost of $10 billion. You are asked to advise the CEO as to what prices and
quantities BMW should set for sales in Europe and in the United States. The demand for
BMWs in each market is given by:
QE = 4,000,000 100 PE and QU = 1,000,000 20PU
Where the subscript E denotes Europe, the subscript U denotes the United States. Assume that
BMW can restrict U.S. sales to authorized BMW dealers only.
(a) What quantity of BMWs should the firm sell in each market, and what should the price
be in each market? What should the total profit be?
(b) If BMW were forced to charge the same price in each market, what would be the
quantity sold in each market, the equilibrium price, and the companys profit?
2. A monopolist is deciding how to allocate output between two geographically separated
markets (East Coast and Midwest in USA). Demand and marginal revenue for the two markets
are:
P1 = 15 Q1

MR1 = 15 2Q1

P2 = 25 2Q2

MR2 = 25 4Q2

The monopolists total cost is C = 5 + 3(Q 1 + Q2). What are price, output, profits, marginal
revenues, and deadweight loss (i) if the monopolist can price discriminate? (ii) if the law
prohibits charging different prices in the two regions?
3. Suppose a profit-maximizing monopolist producing Q units of output faces the demand
curve P = 20 - Q. Its total cost when producing Q units of output is TC = 24 + Q2. The fixed
cost is sunk, and the marginal cost curve is MC = 2Q.
(a) If price discrimination is impossible, how large will the profit be? How large will the
producer surplus be?
(b) Suppose the firm can engage in perfect first-degree price discrimination. How large will
the profit be? How large is the producer surplus?
(c) How much extra surplus does the producer capture when it can engage in first-degree
price discrimination instead of charging a uniform price?
4. Suppose a monopolist producing Q units of output faces the demand curve P = 20 - Q. Its
total cost when producing Q units of output is TC = F + Q2, where F is a fixed cost. The
marginal cost is MC = 2Q.
(a) For what values of F can a profit-maximizing firm charging a uniform price earn at least
zero economic profit?
(b) For what values of F can a profit-maximizing firm engaging in perfect first-degree price
discrimination earn at least zero economic profit?
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5. A firm serving a market operates with total variable cost TVC = Q2. The corresponding
marginal cost is MC = 2Q. The firm faces a market demand represented by P = 40 - 3Q.
(a) Suppose the firm sets the uniform price that maximizes profit. What would that price be?
(b) Suppose the firm were able to act as a perfect first degree price-discriminating
monopolist. How much would the firms profit increase compared with the uniform profitmaximizing price you found in (a)?

6. A natural monopoly exists in an industry with a demand schedule P = 100 - Q. The

marginal revenue schedule is then MR = 100 - 2Q. The monopolist operates with a fixed cost
F, and a total variable cost TVC = 20Q. The corresponding marginal cost is thus constant and
equal to 20.
(a) Suppose the firm sets a uniform price to maximize profit. What is the largest value of F
for which the firm could earn zero profit?
(b) Suppose the firm is able to engage in perfect first degree price discrimination. What is the
largest value of F for which the firm could earn zero profit?
7. Suppose a monopolist is able to engage in perfect first-degree price discrimination in a
market. It can sell the first unit at a price of 10 euros, the second at a price of 9 euros, the
third at a price of 8 euros, the fourth at a price of 7 euros, the fifth at a price of 6 euros, and
the sixth at a price of 5 euros. It must sell whole units, not fractions of units.
(a) What is the firms total revenue when it produces two units?
(b) What is the total revenue when it produces three units?
(c) What is the relationship between the price of the third unit and the marginal revenue of the
third unit?
(d) What is the relationship between the price and the marginal revenue of the fourth unit?
8. Fore is a seller of golf balls that wants to increase its revenues by offering a quantity
discount. For simplicity, assume that the firm sells to only one customer and that the demand
for Fores golf balls is P = 100 - Q. Its marginal cost is MC = 10. Suppose that Fore sells the
first block of Q1 golf balls at a price of P1 per unit.
(a) Find the profit-maximizing quantity and price per unit for the second block if Q1 = 20 and
P1 = 80.
(b) Find the profit-maximizing quantity and price per unit for the second block if Q1 = 30
and P1 = 70.
(c) Find the profit-maximizing quantity and price per unit for the second block if Q1 = 40 and
P1 = 60.
(d) Of the three options in parts (a) through (c), which block tariff maximizes Fores total
profits?

9. Elizabeth Airlines (EA) flies only one route: Chicago-Honolulu. The demand for each flight
is Q = 500 P. EAs cost of running each flight is $30,000 plus $100 per passenger.
(a) What is the profit-maximizing price that EA will charge? How many people will be
on each flight? What is EAs profit for each flight?
(b) EA learns that the fixed costs per flight are in fact $41,000 instead of $30,000. Will
the airline stay in business for long? Illustrate your answer using a graph of the demand
curve that EA faces, EAs average cost curve when fixed costs are $30,000, and EAs
average cost curve when fixed costs are $41,000.
(c) EA finds out that two different types of people fly to Honolulu. Type A consists of
business people with a demand of Q A = 260 0.4P. Type B consists of students whose
total demand is QB = 240 0.6P. Because the students are easy to spot, EA decides to
charge them different prices. Graph each of these demand curves and their horizontal
sum. What price does EA charge the students? What price does EA charge other
customers? How many of each type are on each flight?
(d) What would EAs profit be for each flight? Would the airline stay in business?
Calculate the consumer surplus of each consumer group. What is the total consumer
surplus?
(e) Before EA started price discriminating, how much consumer surplus was the Type A
demand getting from air travel to Honolulu? Type B? Why did total consumer surplus
decline with price discrimination, even though total quantity sold remained unchanged?
10. Sals satellite company broadcasts TV to subscribers in Los Angeles and New York. The
demand functions for each of these two groups are
QNY = 60 0.25PNY

QLA = 100 0.50PLA

where Q is in thousands of subscriptions per year and P is the subscription price per year. The
cost of providing Q units of service is given by
C = 1000 + 40Q
where Q = QNY + QLA.
(a) What are the profit-maximizing prices and quantities for the New York and Los Angeles
markets?
(b) As a consequence of a new satellite that the Pentagon recently deployed, people in Los
Angeles receive Sals New York broadcasts, and people in New York receive Sals Los
Angeles broadcasts. As a result, anyone in New York or Los Angeles can receive Sals
broadcasts by subscribing in either city. Thus Sal can charge only a single price. What
price should he charge, and what quantities will he sell in New York and Los Angeles?
(c) In which of the above situations, (a) or (b), is Sal better off? In terms of consumer
surplus, which situation do people in New York prefer and which do people in Los
Angeles prefer? Why?

11. As the owner of the only tennis club in an isolated wealthy community, you must decide
on membership dues and fees for court time. There are two types of tennis players. Serious
players have demand
Q1 = 10 P
where Q1 is court hours per week and P is the fee per hour for each individual player. There
are also occasional players with demand
Q2 = 4 0.25P.
Assume that there are 1000 players of each type. Because you have plenty of courts, the
marginal cost of court time is zero. You have fixed costs of $10,000 per week. Serious and
occasional players look alike, so you must charge them the same prices.

(a) Suppose that to maintain a professional atmosphere, you want to limit membership to
serious players. How should you set the annual membership dues and court fees
(assume 52 weeks per year) to maximize profits, keeping in mind the constraint that
only serious players choose to join? What would profits be (per week)?
(b) A friend tells you that you could make greater profits by encouraging both types of
players to join. Is your friend right? What annual dues and court fees would maximize
weekly profits? What would these profits be?
12. Classic Programs has purchased distribution rights for two television programs that
are ready for syndication. One series, The Detectives, was enormously popular during
its prime time run and will command a large rental fee. The second series, Kittie and
Alma, was a poor parody of a popular series. Kittie and Alma is not expected to be in
demand for syndication. The managers at Classic Programs feel that there are only
two legitimate bidders for the two series. One bidder is a large independent television
station that is carried across the country by cable TV companies. The other bidder is a
youth oriented pay TV network called Kidwork. The independent station and
Kidwork are rarely carried by the same cable companies, so that a successful bid by
one has almost no impact on the willingness of the other to show the programs.
Based upon previous experience, Classic estimates the following reservation prices
for each bidder. Bidding is for the right to show the programs on an unlimited basis.
Independent Station
The Detectives
100,000
Kittie and Alma
15,000

Kidwork
120,000
8,000

a. Assuming that Classic's managers set separate prices for the two programs, what is the
most profitable pricing strategy? (Because of information that is shared within the industry,
different prices for the two bidders are impossible.) How much revenue will be earned?
b. Classic's managers are considering bundling the two programs under a single price. Is
bundling feasible in this instance? Why or why not? If so, what should the bundled price be?
What will total revenue be?

13. Your company sells health food products, and you have recently developed a new
high-protein drink (HPD) as well as a high-carbohydrate energy bar (HCE). As the
product manager for the firm, you are responsible for setting the pricing policy for the
new products. You are considering a bundled package that includes both products,
and you assume the marginal cost of production is zero for planning purposes. You
have identified four basic types of consumers who may buy these new products, and
their reservation prices for the two new products are provided in the following table:
Type
A
B
C
D

HPD
$0.50
$0.80
$1.00
$1.40

HCE
$1.80
$1.10
$0.90
$0.30

a.Suppose you sell the two products separately, and each buyer is expected to
purchase one unit of the product per day. Which prices for HPD and HCE maximize
daily revenue? What is your daily revenue from selling both products to the four
customers under separate pricing?
b.If you offer the two products under a pure bundling strategy, what is the revenue
maximizing bundle price? What is the daily sales revenue from the pure bundling
scheme?
14. Cornucopia Media provides cable television service to several cities in the midAtlantic region. The firm has access to two new channels that focus on reality
television programming, and the marginal cost of providing both new channels is
zero. The first channel is Extreme Scottish Sports (ESS) and appeals to younger
viewers, and the second channel is Delaware Entertainment and Tourism (DET) and
appeals to older viewers. Based on Cornucopias market research, younger viewers
are willing to pay $5 per month for ESS, and their reservation price for DET is $0.50
per month. The same research indicates that older viewers have a reservation price of
$1.00 per month for ESS and $4.00 per month for DET.
a. Please show how Cornucopia media can increase sales revenue by bundling the two
channels rather than selling access to the channels separately.
b. The US Congress has recently considered legislation that would allow cable television
subscribers to purchase access to separate channels (without bundling). If the law is enacted,
what should we expect to happen to sales revenue in cable television markets?
15. A small island near a major city has a beautiful beach. The company that owns the
island sells day passes for the beach, including travel by ferry to and from the beach.
Because the beach is small, the company does not want to sell more than 200
excursion tickets per day. The company knows there are two kinds of visitors: those
who are willing to buy tickets a month in advance and those who want to buy on the
day of the trip. Those willing to buy in advance are typically more price sensitive. The
demand curve for advance purchase excursion tickets is described by P1 = 100 0.2Q1, where Q1 is the number of advance purchase tickets sold at a price of P1. The
demand schedule for tickets by day-of-travel excursions is represented by P2 = 200 0.8Q2, where Q2 is the number of tickets sold at a price of P2.
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a) Suppose the marginal cost of the ferry trip and use of beach is 50 per customer.
What prices should the firm charge for its excursion tickets?
b) If the marginal cost were high enough, the firm would want to sell fewer than 200
tickets. Suppose the marginal cost of the ferry trip and use of beach is 80 per
customer. What prices should the firm charge for its beach excursion tickets?

16. You are the only European firm selling vacation trips to the North Pole. You know
only three customers are in the market. You offer two services, round trip airfare and a
stay at the Polar Bear Hotel. It costs you 300 euros to host a traveler at the Polar Bear
and 300 euros for the airfare. If you do not bundle the services, a customer might buy
your airfare but not stay at the hotel. A customer could also travel to the North Pole in
some other way (by private plane), but still stay at the Polar Bear. The customers have
the following reservation prices for these services:

a) If you do not bundle the hotel and airfare, what are the optimal prices PA and PH,
and what profits do you earn?
b) If you only sell the hotel and airfare in a bundle, what is the optimal price of the
bundle PB, and what profits do you earn?

17. You operate the only fast-food restaurant in town, selling burgers and fries. There are
only two customers, one of whom is on the Atkins diet and the other on the Zone diet,
whose willingness to pay for each item is displayed in the following table. For
simplicity, assume you have zero fixed and marginal costs for each item.

a) If x = 1 and you do not bundle the two products, what are your profit-maximizing
prices PB and PF? Calculate total surplus under this outcome.
b) Now assume only that x > 0. Instead, suppose that you hired an economist who
tells you that the profit-maximizing bundle price (for a burger and fries) is $8, while if
you sold the items individually (and did not offer a bundle) your profit-maximizing
price for fries would be greater than $3. Using this information, what is the range of
possible values for x?