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  



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