Chapter 14 – Applied Problems

1. STIHL, Inc., manufactures gasoline-powered chain saws for professional, commercial, farm, and
consumer markets. To “better serve” their customers, STIHL offers its chain saws in four different quality
lines and associated price ranges: occasional use, midrange, professional, and arborist. Under what
circumstances could offering multiple qualities of a product be price discrimination? What form of price
discrimination might this represent—first-, second-, or third-degree price discrimination? Explain why this
practice could increase profit at STIHL.
Price discrimination (Second degree) is important because each product can be used in different ways by
different consumers. Price discrimination can be used in situations when firms want to enter in every
segment of market as it cannot enter every market at the same price. They have to reframe their price
structure based on consumer marginal valuations while entering into respective markets.
This will no doubt improve the profit level of the company as it allows the consumers to choose their desired
level of price by choosing a higher or lower quantity of goods. Usually second-degree price discrimination
occurs in the form of quantity discounts i.e. a lower price at higher quantities. So, consumers are tempted
to buy more quantity in order to have to pay lower prices. This helps producers to sell larger quantities,
though at a smaller profit margin. However, because of more quantities sold, the overall profit increases.
2. Price discrimination sounds like a socially “bad” thing. Can you think of any reasons why price
discrimination could be viewed as a socially “good” thing?
Price discrimination works by charging different prices from different sets of consumers. It helps create
distinction in the market by setting different prices for different groups of people. Though it is a profitable
act for the monopolists, it is sometimes equally bad for the consumers. For e.g. in cases where producers
charge higher prices in neighborhoods where people have lesser alternatives available, price discrimination
can prove to be harmful to consumer surplus. Also, charging different prices to people based on ethnicity,
gender and skill status also imposes a higher cost on the society at the expense of higher producer profits.
3. In the mid-1990s, long before September 11, 2001, airlines began requiring photo identification to check
baggage and board flights, claiming their fervent commitment to secure and safe air travel. Do you think
the airlines implemented this policy because they could foresee the coming terrorist threat to aviation?
What might be a more plausible explanation for the airlines’ early commitment to photo identification?
Airline industry implemented the policy to have photo identification machines to check baggage before
boarding a flight is a good step towards safe travelling without any extra costs. This will not only help avoid
terror threats but will also help in stopping people from carrying unnecessary things that might prove to be
harmful inner side the flight. Moreover, terrorist attacks can happen anywhere and anytime. Thus, it is
always better to take necessary steps to avoid such mishaps. It is better to be safe than sorry!
4. As markets for some products and services experience greater global competition, what is the likely
consequence for the incidence of price discrimination? Do you think global competition fosters or impedes
price discrimination? Can you give any examples from your own work experience?
Higher competition in the market can either increase or decrease incentives of producers to price
discriminate. However, strong chances are that producers do tend to adopt price discrimination in order to
gain a larger share of customers and extract higher consumer surplus and not allow them to fall in the hands
to products from other markets or producers. E.g. Suppose a new product is launched in the market and
many producers start selling the product at a fixed price. In such a case, in order to earn above normal profits,
a firm might try its hand at price discrimination. It can charge a marginally lower price in the market where
all the producers operate and a higher price in markets where there are lesser producers to sell the product,
like distant villages etc.
5. “Declining block pricing is a crude form of perfect price discrimination.” In what sense is this statement
correct? In what important way is it wrong?
Declining block pricing is a perfect form of price discrimination as it indicates that price of products decreases
as number of units sold increases. This is a crude form of (second degree) price discrimination and is
hopefully correct if consumer buys products in large quantities. This will prove to be profitable for both
producers and consumers. However, it is wrong in the sense that declining block pricing is based on quantity
and leads to a lower price, as against the case of perfect price discrimination where per unit prices are higher
and not lower.
6. The Financial Herald, a weekly newspaper specializing in corporate financial news, is purchased by both
businesspeople and students. A marketing research firm has estimated the two linear demand and
marginal revenue functions shown in the following figure. MRB is the estimated marginal revenue for the
business readers, and MRS is the estimated marginal revenue for the student readers. The production
department at The Financial Herald estimates a linear marginal cost function for newspaper production,
which also is graphed in the following figure. All quantities are in units of 1,000 per week.

a. How many total copies should The Financial Herald print each week?
The total number of copies the newspaper company should print each week equals the number of copies
printed for student readers and business readers. Optimal point occurs at the point where MR = MC. For
business readers, this point occurs at the point of 35,000 copies (approx.) For student readers, this occurs at
the point of 25,000 copies (approx.) Thus, the total copies that should be printed is 60,000 copies
(35,000+25,000).
b. How many copies should be sold to business readers? How many copies should be sold to students?
As it can be seen from the above part (a), the optimal number of copies that should be sold to each class of
readers is: 35,000 copies to business readers; 25,000 copies to student readers.
c. What price should business readers be charged? What price should students be charged?
Corresponding to the optimal quantities, the prices that should be charged to each class of readers is:
$0.60 from student readers; $0.80 from business readers.
7. EZ Sharp Industries, Inc., manufactures the Keen Edge™ line of diamond-abrasive cutlery sharpeners for
home use. EZ Sharp holds a patent on its unique design and can earn substantial economic profit if it prices
its Keen Edge™ products wisely. EZ Sharp sells two models of its Keen Edge™ sharpeners: the Classic, which
is the entry-level model, and the Professional, which has a sonic sensor that controls the speed of the
sharpening wheels. Short-run production of sharpeners is subject to constant costs: AVC = SMC for both
models. The constant costs of production at EZ Sharp Industries are estimated to be:
$20 = AVCC = SMCC
$30 = AVCP = SMCP
where AVCC and SMCC are the constant costs for the Classic model and AVCP and SMCP are the constant
costs for the Professional model. Total fixed costs each month are $10,000. The sole owner of EZ Sharp
also manages the firm and makes all pricing decisions. The owner–manager believes in assuring himself a
200 percent profit margin by using the cost-plus pricing methodology to set prices for his two product
lines. At these prices, EZ Sharp is selling 3,750 units of the Classic model per month and 2,000 units of the
Professional model per month.
a. Using the cost-plus technique, compute the prices the owner-manager charges for the Classic and the
Professional models, based on his required 200 percent profit margin.
Classic Model:
Professional Model:

b. How much profit is EZ Sharp earning each month using the cost-plus prices in part a?

The owner–manager is ready to sell the firm, but he knows the value of the firm will increase if he can
increase the monthly profit somehow. He decides to hire Andrews Consulting to recommend ways for EZ
Sharp to increase its profits. Andrews reports that production is efficient, but pricing can be improved.
Andrews argues that the cost-plus pricing technique is not working well for EZ Sharp and presents a new
pricing plan based on optimal pricing techniques (i.e., the MR = MC rule).
To implement the MR = MC methodology, Andrews undertakes a statistical study to estimate the demands
for two Keen Edge™ products. The estimated demands are:
QC = 6,000 − 75PC + 25PP
QP = 5,000 − 50PP + 25PC
where QC and QP are the monthly quantities demanded of Classic and Professional models, respectively,
and PC and PP are the prices of the Classic and Professional models, respectively. Andrews Consulting
solved the demand equations simultaneously to get the following inverse demand functions, which is why
Anderson gets paid the “big bucks”
PC = 136 − 0.016QC − 0.008QP
PS = 168 − 0.008QC − 0.024QP
c. Find the two marginal revenue functions for the Classic and Professional model sharpeners.
d. Set each marginal revenue function in part c equal to the appropriate cost and solve for the profit-
maximizing quantities.
e. Using the results from part d, what prices will Andrews Consulting recommend for each of the models?
f. When the owner–manager sees the prices recommended by Andrews Consulting, he brags about how
close his simple cost-plus pricing method had come to their suggested prices. Compute the profit EZ Sharp
can earn using the consultants’ prices in part d. Is there any reason for the owner–manager to brag about
his cost-plus pricing skills?
8. Although there is relatively little difference in the cost of producing hardcover and paperback books,
these books sell for very different prices. Explain this pricing behavior.
Paperback books and hardcover books are sold at very different prices even when there is hardly any
difference between the costs of producing both. The major difference between the hardcover books and
paperback books is that the hardcover books are more durable and pages are stitched in this type of book
which makes the chances of tearing of book less but in case of paperback books pages are attached with
each other with the help of glue which is not that durable. Books are not for the purpose of use and throw.
People keep books with them and prefer hardcover book over paperback books as it is more durable and
long lasting. So, their higher preferences of hardcover book make this kind of book to be sold at higher prices.
9. The Wall Street Journal once reported on dating services, noting that the fees were $300 for men and
$250 for women. The owner of the service said that the difference in fees was to compensate for
inequalities in pay scales for men and women. Can you suggest any alternative reasons for this difference?
The reason stated by the owner of dating services with respect to difference in the fees for men and women
was to compensate for inequalities in pay scales for men and women. However, another reason that can
hold true in this regard can be that women are more interested than men to avail these services. Charging
lower prices from women in that case will increase more and hence their earning will also increase more as
compared to when men avail dating services.
10. Berkley Golf & Tennis Club offers golf and tennis memberships. Marketing analysis of the local
neighbourhood served by Berkley Golf & Tennis Club shows that there are two types of families that might
join the club: golf-oriented families, which are primarily interested in golf but enjoy playing some tennis,
and tennis-oriented families, which are primarily interested in tennis but enjoy playing some golf. The
study further estimates that there are 400 golf-oriented families and 300 tennis-oriented families in the
neighbourhood, and the estimated demand prices for golf and tennis memberships by family type are
given below. There is no way to identify family types for pricing purposes, and all costs are fixed so that
maximizing total revenue is equivalent to maximizing profit.

a. If Berkley Golf & Tennis Club plans to offer golf and tennis memberships separately, what prices should
be charged for each kind of membership if Berkley wishes to maximize profit? How much total revenue
can be generated each month under this pricing plan?
In order to maximize their profit, golf club should charge $250 for golf membership only and $200 for tennis
membership only. Total revenue that can be earned by these clubs together each month is (250 x 400) +
(200 x 300) = 160,000.
b. The manager of Berkley Golf & Tennis Club has just finished her MBA degree and has an idea that
bundling golf and tennis memberships might increase profit for the club. Are the conditions right for
bundle pricing to increase profit at Berkley Golf & Tennis?
Bundle pricing is a good strategy if a person likes both the games. But in this case when different families
like and want to play a particular game, this bundle pricing strategy does not stand to be a good strategy as
it will create an extra burden on the consumers which might affect the sales.
c. What is the optimal price to charge for a golf and tennis (bundled) membership? How much revenue
will this produce for Berkley Golf & Tennis Club? Is bundling a profitable pricing tactic for the club?
While opting for bundle pricing, the club should either change $50 or $100 depending upon the ratio of the
people who are interested in playing games. If the number is more in golf, then they can charge price of $50
but if the person is tennis oriented then they can adopt bundle pricing of $100. This will help them in
maintaining profits and also increase their numbers.
11. Airlines practice price discrimination by charging leisure travelers and business travelers different
prices. Different customers pay varying prices for essentially the same coach seat because some
passengers qualify for discounts and others do not. Because the discounts are substantial in many cases,
the customer who qualifies for a discount pays a significantly lower airfare.
a. Which group of customers tends to pay the higher price: business travelers or leisure travelers?
Business travelers tend to pay higher fares or prices because for them travelling is the main motive and they
do not care about the price. They want comfort and quick services and are thus ready to pay higher fares for
the same. Leisure travelers on the other hand look for lower fares to fit in their budget. They do not look for
comfort or services and are only concerned with minimizing their costs.
b. Why would business travelers generally have a different elasticity of demand for air travel than leisure
travelers? Is the more elastic market paying the lower or higher price? Is this consistent with profit
maximization?
Business travelers have a lower elasticity of demand for air travel as their demand for air travel does not get
affected by the prices. For them the work for which they are travelling is more important. In case of leisure
travelers, the price elasticity of demand is higher as for them minimizing the cost is more important. They
are ready to postpone their holiday trip if they foresee a drop in airfares in the future. So, the lower elastic
market ends up paying higher prices than those with elastic demands.
Airlines rely on an assortment of restrictions that travelers must meet to qualify for the discounted fares.
In effect, these restrictions roughly sort flyers into business travellers and leisure travelers.
c. Explain how each of the following restrictions sometimes used by airlines tends to separate business
and leisure travelers.
(1) Advance purchase requirements, which require payment at least 14 days before departure.
If a person is booking tickets well in advance, it means that the customer falls under the category of leisure
customer as such travelers plan their trip well in advance. So, when they get discounts on fares, they will
be more than happy to buy them.
(2) Weekend stay requirements, which require travelers to stay over a Saturday night before returning.
Saturday is quite a busy day for travellers because people are in a hurry to finish off their work and get to
their offices by Monday. With this, the travel companies tend to separate business and leisure travellers by
giving more priority to business travellers, so that they are able to get tickets easily.
(3) Time-of-day restrictions, which disallow discounts for travel during peak times of the day.
This type of time restriction, which disallows discounts for travelling during peak time of the day help to sort
business travelers from leisure travelers. Since business travelers usually travel during peak times of the day,
they would end up not being able to avail the discounts and thus paying higher prices.
d. In each of these cases, which group of passengers effectively pays a higher price for air travel? Is this
consistent with profit maximization?
In all these cases, it is the business travelers who end up paying more because of their price inelastic demand
for air travel. Companies try to maximize their producer surplus by making complete use of their price
inelastic demand.
12. A woman complained to “Dear Abby” that a laundry charged $1.25 each to launder and press her
husband’s shirts, but for her shirts—the same description, only smaller—the laundry charged $3.50. When
asked why, the owner said, “Women’s blouses cost more.” Abby suggested sending all the shirts in one
bundle and enclosing a note saying, “There are no blouses here—these are all shirts.”
a. Is the laundry practicing price discrimination, or is there really a $2.25 difference in cost?
The laundry is clearly engaging in price discrimination. There is no difference in the cost of cleaning the two
pieces of clothes. The laundry is just trying to cash in on the inelastic nature of demand for laundry by
women.
b. Assuming the laundry is engaging in price discrimination, why do men pay the lower price and women
the higher?
Prices charged from women are higher as compared to those charged for men as this is the notion which is
being followed since long. Women have always been paid less and charged more. This form of gender
discrimination has now entered the product markets, thus exploiting them in every possible aspect.
c. Could the laundry continue to separate markets if people followed Abby’s advice? What about the
policing costs associated with separating the markets?
If people followed Abby’s advice, then this would help in stopping the separation of markets only in the short
run. This is because discrimination exists in all types of markets and in every possible respect. Just by giving
the name of shirt to women blouses does not make them one. There are many other product markets where
discrimination on the basis of gender exists. So, in the long run, this won’t work.
13. A bar offers female patrons a lower price for a drink than male patrons. The bar will maximize profit
by selling a total of 200 drinks (a night). At the current prices, male customers buy 150 drinks, while female
customers buy 50 drinks. At this allocation between markets, the marginal revenue from the last drink
sold to a male customer is $1.50, while the marginal revenue from the last drink sold to a female customer
is $0.50.
a. What should the bar do about its pricing?
It is given that the bar discriminates its patrons on the basis of gender. Female patrons are offered drinks at
a lower price than males. This is a price-discriminating tactic by the bar in order to increase the number of
its customer and also earn more profits. The bar can maximize its profits by increasing the number of drinks
sold to its male customers. This is because profits of a firm are maximized only when the MR of the product
in both the markets come out to be equal.
b. If the bar sells 151 drinks to males and 49 to females, what will be the increase (decrease) in total
revenue?
If the bar sells one extra drink to males and one less to females, its total revenue will increase, but only by a
very small amount. This is because the MR from the last drink sold to males is more than that for females.
However, if the number of drinks sold to male customers increases by a very large amount, its TR will increase
rapidly.