Week 8 term 1 Flashcards
(50 cards)
What is the definition of second-degree price discrimination?
Second-degree (indirect) discrimination is where prices are based on observable characteristics of the purchase (e.g., volume), correlated with customer preferences.
How does a monopolist implement second-degree price discrimination?
By offering a menu of price-quantity bundles tailored to different consumer types, allowing for self-selection.
- incentive compatibility since the monopolist does not have the knowledge of the demand of each individual or group
What is nonlinear pricing?
Nonlinear pricing occurs when a consumer’s total expenditure on an item does not rise linearly with the amount purchased.
Price per unit varies with the number of units the consumer buys.
What characterizes the utility function of a consumer in the nonlinear pricing framework?
U = θV(q) - T(q) where T(q) is expenditure, V’ > 0, and V’’ < 0.
What does θ represent in the context of consumer utility?
θ denotes the type of the consumer, reflected through preferences.
What are the two types of consumers in the nonlinear pricing framework?
High demand and low demand consumers with preferences θh and θl respectively.
What is the profit function of the monopolist?
πm = λ(T1 - cq1) + (1 - λ)(T2 - cq2)
What is the Individual Rationality (IR) constraint?
It requires that consumers are willing to purchase the good at the offered price-quantity bundles, ensuring non-negative net surplus for low-demand consumers.
What does the Incentive Compatibility (IC) constraint entail?
It requires that a consumer chooses the bundle directed at them, preventing them from opting for a bundle intended for another type.
What must be satisfied for profit maximization by the monopolist?
Both the Individual Rationality (IR) and Incentive Compatibility (IC) constraints must be satisfied with equality.
Fill in the blank: The marginal cost of production to the monopolist is _______.
constant and equal to c.
True or False: The monopolist can serve both types of consumers if λ is sufficiently large.
True.
What condition guarantees that high-demand consumers get a positive payoff?
θhV(q1) - T1 > θlV(q1) - T1 ≥ 0.
What is the significance of the quantity purchased by high-demand consumers?
It is socially optimal since the marginal utility of consumption equals the marginal cost.
What is required for the low-demand consumers not to choose the high-demand consumers’ bundle?
θlV(q1) - T1 ≥ θlV(q2) - T2.
What does the term ‘self-selection’ refer to in price discrimination?
It refers to consumers choosing the price-quantity bundle that corresponds to their willingness to pay.
What happens if the net surplus for low-demand consumers is negative?
They will not purchase the good at the offered bundles, violating the Individual Rationality constraint.
What must be true for the high-demand consumers to reveal their willingness to pay?
The Incentive Compatibility constraint must be satisfied.
What are the two types of consumers in the numerical example?
θh (high type) and θl (low type)
What types of bundles does the monopolist offer?
- (q1, T1) directed at low type consumers
- (q2, T2) directed at high type consumers
What are the two constraints faced by the monopolist?
- Individual Rationality (IR)
- Incentive Compatibility (IC)
What does the Individual Rationality (IR) constraint require?
Consumers should obtain non-negative payoff from buying the good
What does the Incentive Compatibility (IC) constraint imply?
Consumers should choose a bundle directed at them
What condition must hold for high type consumers in the IC constraint?
They should not want to consume the low type consumers’ bundle
