PRINCIPLES OF ECONOMICS
Prof. Michael Horvath
Price discrimination strategy is when a product/good is sold at different prices to different consumers, whereas single pricing strategy is one in which same price is charged to all consumers.
An owner of a sub shop in a college town can adopt the price discrimination strategy in order to maximize its profit. The owner categorizes its customers in 3 types:
1) Students, who are not willing to pay high prices, and their demand elasticity is high.
2) Senior citizens, who have lower income and will not pay high price for a sub, their demand elasticity is high too.
3) Other ...view middle of the document...
Third, other people will be given no deals or promotion, which means they will b charged at a higher price as compared to students and senior citizens.
Therefore, the owner will be able to maximize its profit by adopting price discrimination strategy.
QUESTION # 2
If legislature sets the cable maximum price that is less than the equilibrium price, the result is permanent excess demand for the cable. Excess demand occurs when, at the prevailing market price, the quantity demand exceeds quantity supplied; means now there are lot of consumers available and they are willing to buy more connections than Cable Company is willing to sell.
Area between point A and B shows excess supply at $100.00
Area between point C and D shows excess demand at $50.00
Point E is the market equilibrium point where demand of cable connections equal to connections supplied by Cable Company. At $ 50.00 there is an excess demand of 60,000 connections (80,000-20,000). Consumers are willing to buy 60,000 connections, but the cable company is willing to sell only 20,000 connections because price is less than the marginal cost of supplying connection number 20,001 and beyond. This mismatch between demand and supply will cause the price of cable connection to rise. Cable company will increase the price they charge for their limited supply of connections, and consumer will pay the higher price ultimately to get one of the few connections available.
An increase in price eliminates excess demand by changing both quantity demanded and quantity supplied. As the price increases, excess demand shrinks for two reasons: market moves upward along the demand curve from point D to E, decreasing the quantity demanded, secondly; market moves upward along the supply curve from point C towards point E, increasing the quantity supplied.
Because the quantity demanded decreases while the quantity supplied increases, the gap between quantity demanded and quantity supplied narrows. The price will continue to rise until excess demand is eliminated.
In reference to disgruntling customers are concerned, Cable Company can use price discrimination strategy to attract them. It’s very important to keep in mind that Cable company is a classic example of natural monopoly, because the economies of scale for supplying all connection is on such a large scale that only one company can survive, and even city legislature also preferred one company, because it is efficient to have a single set of cables for TV service.
Because of indivisible inputs of cable service system, the long run average cost curve is negatively slopped, reflecting the large economies of scale for cable service. With this it’s easy for cable company to give discounts to certain groups (like senior discount), or design different packages (reducing number of channels) with cheaper prices to attract disconnected/ disgruntled customer as far as this price is more than the average cost.