Price Discrimination

Assume that there is a single monopoly supplier of gadgets, but there are two distinct types of consumers, with the following individual demand curves:

Type α: qα = 100 - 2pα

Type β: qβ = 80 - 3pβ

There are five consumers of type α and ten of type β. All consumers are price takers. The firm's marginal cost of production is £1, and there are no fixed costs.

a) Suppose the monopolist can identify consumers according to their type. What price should the firm charge each type of consumer in order to maximize its profits? Calculate the following for each consumer, and in aggregate: (i) the firm's profits, (ii) consumer surplus and (iii) deadweight loss.

Suppose now that a law is passed which makes it illegal to offer different prices to different consumers.

b) Derive and graph the aggregate demand curve and aggregate marginal revenue curve.

c) Calculate the profit maximising uniform price, as well as the quantity, profits, consumer surplus and dead weight loss under the uniform price.

The law does not prohibit two-part tariffs, as long as they are available to all consumers. The firm decides to offer the following two pricing options:

Option A: Pay a fixed contract fee of £800 and then £5 per individual unit Option B: A fixed contract fee of £400, and a variable price per unit of £10

d) Show that these two-part tariffs are both participation compatible (i.e. that both types of consumer choose to buy) and incentive compatible (i.e. that each type chooses a different option).

e) Show that the firm prefers the two-part tariffs to the uniform price.

f) Compare social welfare and the well-being of each of the agents (firm, high valuation consumer, and low valuation consumer) under:
i. group pricing (part a),
ii. uniform pricing (parts b,c), and
iii. menu pricing (parts d,e).
Explain intuitively what drives these results?