ECON 201:

Problem Set 4

April 4, 2022

Reading
• Varian: 24, 25

Problem 1.
Consider a monopolist with demand D(p) = 200 − 2p and marginal cost are constant and
given by MC = 15. Determine profit, consumer surplus, and social welfare in the following two
cases:

1. Uniform price monopolist

2. Perfect price discrimination.

Problem 2.
You are a taxi driver in Astana who stops by a passenger traveling to the airport. This
person can be either a student, a professor or a dean. You know that they are willing to pay
up to 400, 900 and 3500 tenge respectively (they agree to take a taxi if the price is equal or less
than this amount). You know also that out of all the people taking taxis 60% are students, 30%
are professors and 10% are deans. When you offer a price and a traveler accepts, you get a job,
if not, you lose a client. You are going to the airport anyway so the cost of the trip for you is 0.

1. Suppose that you can distinguish each of the three types of travelers, and offer a separate
price for each type. Which price should you offer to each type?

2. Suppose you cannot distinguish them, and so must offer a single price. What price should
you offer to make the highest possible amount of money (on average)? Show your compu-
tations and explain.

3. Suppose now that 70% of professors look like students and the rest look like deans, while
deans and students are definitely distinguishable. So you can price discriminate only be-
tween this two groups. What should you do to earn the highest possible amount of money?
Show your computations and explain.

Problem 3.
In 1999, Coca-Cola announced that it was developing a “smart” vending machine. Such
machines are able to change prices according to the outside temperature. Suppose, for the
purposes of this problem, that the temperature can be either “High” or “Low.” On days of “High”

1
temperature, demand is given by Q = 280 − 2p, where Q is number of cans of Coke sold during
the day and p is the price per can measured in cents. On days of “Low” temperature, demand is
only Q = 160 − 2p. There is an equal number days with “High” and “Low” temperature. The
marginal cost of a can of Coke is 20 cents.
1. Suppose that Coca-Cola indeed installs a “smart” vending machine, and thus is able to
charge different prices for Coke on “Hot” and “Cold” days. What price should Coca-Cola
charge on a “Hot” day? What price should Coca-Cola charge on a “Cold” day?
2. Alternatively, suppose that Coca-Cola continues to use its normal vending machines, which
must be programmed with a fixed price, independent of the weather. Assuming that Coca-
Cola is risk neutral, what is the optimal price for a can?
3. Now, suppose that Coca-Cola is risk averse with utility of profit x given by ln(x), and
it maximizes its expected utility (not profit).What is the optimal fixed price for a can?
(assume that the probability of cold day, equal to the probability of hot day).
Problem 3.
Astana Arena stadium has a capacity of 50k and is used for exactly seven football games a
year. Three of these are OK games, with a demand for tickets given by D(p) = 150 − 3p per
game, where p is ticket price. (For simplicity, assume there is only one type of ticket.) Three of
the season games are not so important, the demand being D(p) = 90 − 3p per game. Finally,
one of the games is really big, the demand being D(p) = 240 − 3p. The costs of operating the
Stadium are essentially independent of the number of tickets sold.
1. Determine the optimal ticket price for each game, assuming the objective of profit maxi-
mization. Remember that the stadium capacity is limited.
2. Given that the Stadium is frequently full, the idea of expanding the Stadium has arisen. A
preliminary study suggests that the cost of capacity expansion would be $100 per seat per
year. Should the stadium expand its capacity? Hint: you need to compare marginal cost
of capacity with stadiums marginal revenue.
Problem 4.
Your software company has just completed the first version of SW, a voice-activated word
processor. As marketing manager, you have to decide on the pricing of the new software. You
commissioned a study to determine the potential demand for SW. From this study, you know
that there are essentially two market segments of equal size, professionals and students (one
million each). Professionals would be willing to pay up to $400 and students up to $100 for the
full version of the software. A substantially scaled-down version of the software would be worth
$50 to consumers and worthless to professionals. It is equally costly to sell any version. In fact,
other than the initial development costs, production costs are zero. Although you know there are
two market segments, you cannot directly identify a consumer as belonging to a specific market
segment.
1. What are the optimal prices for each version of the software.
2. Suppose that, instead of the scaled-down version, the firm sells an intermediate version
that is valued at $200 by professionals and $75 by students. What are the optimal prices
for each version of the software? Is the firm better off by selling the intermediate version
instead of the scaled-down version?

2
Problem 5.

1. Consider the price discrimination example we discussed in the class. A firm produces two
goods, with one being a downgraded (worse) version of the other. Suppose that each good
has zero cost of production. There are N (even) consumers. Half of the consumers have high
valuations: their valuation of good 1 is 100, and of good 2 is v H < 100. The other
n half
o are
L H
low valuation consumers: they value good 1 for 90, and good 2 for v < min 90, v . So
the valuation of consumers in the first group of each good is higher than the corresponding
valuation of consumers in the second group. Also note that good 2 is considered worse by
both groups of consumers – each group is willing to pay less for it than for the other good.
The firm cannot charge different prices for the same good to different consumers.

(a) In the class showed that when (v H , v L ) = (94, 89) the firm increases it’s profits by
selling both versions of the good. Clearly it is not true in general. Characterize all pairs
(v H , v L ) such that selling both versions is more profitable for the firm than offering
only a better version (that is mathematically describe a set of such pairs). Carefully
describe all the steps of your analysis. If you make some additional assumptions, you
must explicitly introduce them.
(b) Prove that for each (v H , v L ) such that selling both versions is more profitable for
the firm than offering only a better version, the social welfare defined as the sum of
consumer and producer surplus is lower when a firm can sell both versions, than when
it can sell only the better version of the good.
(c) The above observation is not as intuitive as it might seem. In fact it is possible that
the social welfare goes up when a firm can introduce the downgraded version of a
product. Find an example that demonstrating this. You can assume that there are
still two groups of consumers. Find the number of consumers in each group, and their
valuations of each good that yields you a desired conclusion.