PROBLEM SET 8.

1 – ON PRICE DISCRIMINATION

1. For a monopolist, a “non-linear pricing strategy” is referred to as a “perfectly

discriminating strategy” if the pricing structure manages to extract the entire consumer
surplus in the market.
Let us understand such perfectly-discriminating pricing by returning to our “helicopter
monopolist”. She faces 100 consumers, each with utility function U(X, Y) = [1000X + Y]
and income = Rs. 10000, where X is the number of hours of helicopter travel and Y is the
number of cups of tea drunk. Suppose that the price of tea is 1 rupee per cup, and the
helicopter monopolist has the cost structure: unit cost = Rs. 60 per hour.
Determine the “perfectly-discriminating” two-part tariff for the monopolist, and identify the
amount of consumer surplus that the tariff extracts from each consumer.

2. There are 10,000 households in country A, and of these (10000 – 5PA) households will buy
an Ultrabook when its price is PA – i.e., the demand for Ultrabooks in country A is: QD (A) =
10000 – 5PA. There are 30,000 households in country B, and of these (30000 – 20PB)
households will buy an Ultrabook when its price is PB – i.e., the demand for Ultrabooks in
country B is: QD (B) = 30000 – 20PB.
Ultrabooks are manufactured by a global monopolist UltraComputers, whose constant unit
cost of production is Rs. 500 per Ultrabook (all demands and prices are expressed in rupees).
Given that resale of Ultrabooks between the two countries is not possible, determine the
profit-maximizing prices PA* and PB* that the monopolist should set in the two countries.
What is UltraComputers’ market power in each of the two countries?

3. A monopoly car-dealership AutoMax sells a particular brand of car – the Maxmobile (M).
AutoMax can acquire each Maxmobile at a cost of Rs. 3 million.
Each Maxmobile can be fitted with an accessories package ‘Goodies’ (G) (stereo system,
spoiler, fog lights, etc.), which has to be bought from the market at a price of Rs. 1 million.
AutoMax has no ‘cost advantage’ in buying Goodies as compared to retail consumers.
There are two sets of consumers in town – one hundred Generation X consumers, and one
hundred Generation [X–1] consumers. Each of these potential buyers has the following
“valuations” for a Maxmobile and a {Maxmobile + Goodies}:

Maxmobile (M) Maxmobile + Goodies (M+G)

Generation X (100) 5 million 6.75 million
Generation [X–1] (100) 6 million 6.5 million

Each consumer wants to choose that product/bundle for which the net payoff – {own value of
product/bundle – total price paid} – is the largest. Further, if a consumer buys only the
Maxmobile from Automax, she can always additionally buy the Goodies from the market
paying the price of Rs. 1 million.

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PROBLEM SET 8.1

While Automax knows the “valuation distribution matrix” presented above, it cannot
distinguish between a Generation X consumer and a Generation [X–1] consumer by sight.
AutoMax has three choices: (1) Sell only the Maxmobile at the profit-maximizing price
P(M). (2) Sell only the ‘bundle’ {Maxmobile + Goodies} at the profit-maximizing price
P(M+G). (3) Offer the following ‘menu’ to the consumers: {[(Only Maxmobile) at price
p*(M)], [(Maxmobile + Goodies) at price p*(M+G)}?
Which selling strategy should AutoMax pursue, and at what price(s), to maximize its profit?