Question

A monopoly that sells coconuts to two groups of consumers in different parts of an island. Group 1’s elasticity of demand is 3.5, while group 2’s is -2.9. Your marginal cost of producing the product is $70. ©

a. What is the best type of price discrimination this firm can engage in? Why?

b. Without calculation, the price charged to which group would be the higher price? Why?

c. Calculate the prices that should be charged to the 2 groups.

Answer 1

Q1) The best type fo price discrimination is the First degree price discrimination, where the monopolist knows the maximum willingness to pay for each consumer and charges that price. There is no deadweight loss as all consumer surplus is transferred to producer surplus.

Q2) The price charged will be higher for the group whose elasticity fo demand is lower (Group 2 with elasticity 2.9). This is because if the monopolist charges a higher price for high elasticity group, the fall in demand will be very high and the total revenue = Price*Quantitiy will fall. The opposite is true for high prices in lower elasticity groups.

Q3) From Lerners index we know that,

(P - MC / P) = 1/elasticity

Group 1:

(P - 70/ P) = 1/3.5

=> 3.5P - 245 =P

=> P = 245 / 2.5 = 98

Group 2:

(P - 70/ P) = 1/2.9

=> 2.9P - 203 = P

=> P = 203 / 1.9 = 106.84