2011

TJC H2 Economics MCT EQ 1

Fast food restaurants often issue coupons which enable meals to be purchased at a discount. (a) Explain whether the above is an example of price discrimination. (10) (b) Discuss whether such practices benefit producers or consumers more. (15) (a) Explain whether the above is an example of price discrimination. (10) L1: Define price discrimination identify the conditions of price discrimination (1-3) Price discrimination refers to the practice of charging different consumers different prices for an identical product for reasons not associated with differences in costs The conditions for PD to occur o The firms must be a price setter o Different buyers have different price elasticities of demand (PED) o Segmentation of buyers is possible o Seepage between buyers is limited L2: Explain the conditions for price discrimination to occur (4-6) To set different prices for different consumers, a firms must be a price setter i.e. the market must be either a monopoly, oligopoly or monopolistic competition Higher prices are charged for buyers who are willing to pay more i.e. those with more inelastic PED Firms must be able to identify and separate which buyers are willing to pay more Those who bought at a lower price must be unable or unwilling to re-sell the good to others L3: Analyse whether the above are examples of price discrimination (6-10) Fast food restaurants are price setters because the food sold is differentiated e.g. Macdonald's food tastes different from Burger King The price of a meal forms a smaller proportion of income for the rich than the poor the rich are willing to pay more and hence have more inelastic PED Buyers are separated by the coupons buyers with higher PED are the ones who will bother with keeping and using the coupons Seepage is limited while consumers with coupons may share extra coupons with their family and friends, they are unlikely to be willing to pass them to strangers However, the meal on the coupon is sometimes a little different from the standard meal e.g. the coupon meal may have less items this is not considered as PD as the meal is no longer identical and neither is the cost of producing the meal

2011 TJC H2 Economics MCT EQ 1

(b) Discuss whether such practices benefit producers or consumers more. (15) L1: Recognize that with PD, firms generally benefit at the expense of consumers (1-2) PD causes consumer surplus to be transferred to producers Producers earn more profit while some consumers suffer from higher prices L2: Explain and illustrate how PD benefit producers at the expense of consumers (3-8) If there is no PD, the firm sets the price and output where MC=MR With 1st degree PD, the demand curve becomes the new MR curve as the firm does not have to lower price of previous units in order to sell the extra unit The new profit max output with PD is where MC = MR2 = DD As all consumer surplus is now transferred to the producer, this implies that producers benefit at the expense of consumers (Explain and Illustrate with figure 1 in Market Structure Issues lecture notes) Although the analysis is done with 1st degree PD, the implications can be extended to all forms of price discrimination L3: Analyze how consumers can also benefit from PD in the given example (9-11) Some consumers who did not consume the good previously now get to consume the good so they benefit from the utility gained from such consumption Without coupons, poorer individuals may find the non-discounted price of a fast food meal too expensive and not buy the meal, but with the discount coupons, they now buy and enjoy the meal E: Discuss whether producers or consumers benefit more in the given example (+4) Ideally, to maximize profits, a fast food restaurant would give the coupons to consumers who would not have bought the meal at the full price However given that it is not possible to identify such consumers, discount coupons are usually given out randomly e.g. inserted into newspapers so some who were actually willing to pay the full price now get to pay the discounted coupon price Consumers who use the coupons definitely gain while those who do not use the coupons do not loose as the standard price of the meal usually remains unchanged On the other hand, the firm only benefits if the gain in profits from the new customers exceed the loss in profits from the existing customers who now pay less While the benefits to the restaurant are uncertain, consumers clearly benefit Thus it seems that consumers are likely to benefit more than producers from the use of discount coupons

2011 TJC H2 Economics MCT EQ 1

Common Mistakes Part (a) Inaccurate definition of price discrimination o Many definitions did not include " for reasons not associated with differences in costs" Irrelevant definition, analysis and application of both 1st and 2nd degree PD when the question is clearly about 3rd degree PD Failure to recognize the possibility of self selection in this case of PD i.e. only those with more elastic demand would really bother to use the coupons Inability to distinguish between the PED of a firm and PED of a market o Youths in general like fast food and older people don't so the market demand for fast food is relatively more price elastic for the latter o However the demand for a particular type/brand of fast food by youths is actually more elastic than for older adults i.e. since youth like to eat fast food, they will shop around base on price while an older adult would only eat fast food if he is force by circumstances e.g. no other food nearby, he is pressed for time, he is pestered by his children Seepage/resale only needs to be limited but not necessarily non-existent o Seepage due to passing coupons among friends and family is not severe enough to prevent PD Part (b) Irrelevant analysis of allocative efficiency and equity o These are outcomes are the concerns of society and not of consumers o Consumers are concern with price, output, consumer surplus, product variety and quality Irrelevant analysis that aims to 'hijack' the question by discussing other areas of market structure e.g. o PD benefits the consumers because higher profits create more incentive and ability to engage in R&D to improve product quality o Coupons are used as advertising so consumers suffer from buying less suitable products due to brand loyalty Irrelevant analysis of cross subsidisation o Cross subsidisation is relevant for the provision of basic needs like healthcare or public transport and not for frivolous consumers goods like fast food Irrelevant analysis of 2nd degree PD o While 1st degree PD is still somewhat relevant because it shows how consumer surplus is transferred to producers, there is totally no need to analyse 2nd degree PD