Required Homework

This assignment is worth 15 points. It can be submitted online before June 7 or turned in at the final exam.

1. (third-degree price discrimination-5 points) A local restaurant charges its regular customers (who are not senior citizens) $15 for a dinner entrée and $10 for a lunch entrée. The estimated price elasticity of demand for regular customers is 2 at dinnertime.

What is the price elasticity of demand for regular customers at lunchtime?

Senior citizens qualify for a 10 percent discount at the restaurant for either lunch or dinner. If the restaurant is maximizing profits, what arethe price elasticities of senior citizens at lunchtime and dinnertime, respectively?

Assume that the marginal cost of providing an entrée to a customer does not depend on the time of day or the age of the customer.

Show your work to get full credit.

2. Use your knowledge about price-searching firms and two-part pricing to advise the company below (10 points)

The company has a bar and is trying to decide on the cover charge (if any) and price for each drink.  It has done a modest regression study in which it asked customers to classify themselves as light drinkers or heavy drinkers and to indicate the number of drinks they would typically consume during the evening.

The estimate from the regression study is that a change in the price equal to $1 per drink causes light drinkers to change their consumption on average by 0.5 drinks per night.  However, a change in price of $1 causes heavy drinkers to change their consumption on average by 1.0 drink per night.  For both groups a typical consumer will not consume anything once the price reaches $9 per drink. (They may instead go to another bar or not go to a bar at all.)

Draw a demand curve for a typical light drinker and for a typical heavy drinker on the same diagram.  Explain your diagram.  Write equations for the curves in slope-intercept form.

If 300 people visit the bar on a typical evening, with 200 people being light drinkers and 100 people being heavy drinkers, draw an overall demand curve for all of the consumers combined. 

What is the slope and what is the intercept for this demand curve?  Write an equation in slope-intercept form.

Recall that, in the case of a straight-line demand curve, the slope of the marginal revenue line for a company that does not practice price discrimination is double the slope of the (total) market demand curve.        

If the marginal cost of making drinks (the alcohol, the bartender's labor, and the amortized cost of purchasing glasses and cleaning them repeatedly) is constant at $5 per drink, and if no cover charge is assessed, what is the best price to charge for drinks?  How many drinks would be sold on a typical evening? What would your profits be? Show your work. What would be the price elasticity of demand at profit-maximizing price?

If you cut your price by $1 per drink AND assess the maximum possible cover charge without causing a typical light drinker to refuse to enter the bar, would your profits improve? How high would the cover charge be? Calculate both the cover charge and your total profits.  Would the new pricing increase profits? Show your work.

EXTRA CREDIT:  Maybe the best price cut is not exactly $1. Write a profit equation.  Profits equal total revenue minus total cost.  Total cost equals $5 times the number of drinks sold.  Total revenue equals the price for drinks times the number of drinks sold, PLUS 300 people times the cover charge.  The cover charge equals, for a light drinker, the triangle of consumer surplus above the price but below the demand curve for a light drinker. (The area of a triangle equals one half the base times the height.)

You will take the derivative of the profit equation with respect to P or Q and set it equal to zero. For example, use the equation for the total demand curve and solve for Q in terms of P.  Then in the profit equation substitute in an expression involving P in place of every 'Q' that was in the original profit equation. Now you can take a derivative of profits with respect to P and set the derivative equal to zero.  Eventually you can solve for the exact best P, Q, and cover charge.  Good luck!

Review of slope-intercept form-Y= a - b X; a = the intercept on the Y-axis and b = the absolute value of the slope (slope=(change in Y)/(change in X))

For a demand curve: P=a-bQ

The intercept on the vertical axis would indicate a price that is so high that the quantity demanded becomes zero.

The slope is the ratio of a change in price divided by the change in quantity demanded; the problem gives you information to determine the slope for a light drinker and the slope for a heavy drinker.