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Chapter 07 - Pricing with Market Power
Chapter 07
Pricing with Market Power
Essay Questions
1. The simple case of pricing with market power assumes that (a) all consumers are charged
the same price, (b) the firm sells one product, and (c) demand exists in one time period.
Discuss what happens when each assumption is relaxed.
Answer: When a firm can sell at different prices to different customers, it gives the firm the
opportunity to increase profits by setting higher prices for consumers with relatively more
inelastic demand. It can charge lower prices to consumers with relatively more elastic
demand. When the firm sells multiple products with interrelated demand, the firm must
consider the cross-price effects of change in a single price. Similarly, when consumer demand
in the future depends on consumer decisions today, today's price will affect future demand.
For example, a company meeting consumers’ shaving needs sets a low price for razors today
to sell higher-priced razor blades in the future.
Difficulty: 02 Medium
Blooms: Understand
AACSB: Reflective Thinking
Topic: Benchmark Case: Single Price per Unit
2. The simple case of pricing with market power assumes that (a) all consumers are charged
the same price, (b) the firm sells one product, (c) demand exists in one time period, and (d)
competitors do not pursue pricing games. Economists insist on reviewing what happens as
each assumption is relaxed one at a time. But it is clear that in the real world all four are
relaxed simultaneously. Why does economic analysis insist on such an unrealistic analysis?
Answer: The use of models provides an opportunity to perform careful thought experiments
examining cause and effect. Economic analysis that looks at the effects of changing or
relaxing one assumption at a time, holding other factors constant, lets us examine how just
that one factor affects the determination of price in the real world. The use of models,
simplified versions of the real world, provides a better understanding of the role of each of
these factors.
Blooms: Understand
1
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3. A small fitness center that offers only personal training services has the following demand
and cost parameters:
Demand: The fitness center has found that it has some discretion in pricing—that is, it can
raise price marginally without drastic reductions in volume. Based on statistical estimates of
demand and assuming that external factors stay constant (e.g., price of competitors' services,
income levels, etc.), the following relationship exists between the hourly rate for a personal
training session (P) and the number of sessions demanded per day (Q):
P = 140 – Q.
Costs: The fitness center finds that its variable costs (e.g., labor) increase at a constant rate of
$40 with each additional training session provided per day. Fixed costs such as rent are equal
to $200 per day. This yields the following total variable cost (TVC) and total fixed cost (TFC)
equations:
TVC = 40Q.
TFC = 200.
(a) Find the price and quantity demanded (P and Q) that maximize total profit.
(b) What is the maximum possible profit?
Answer: The highest possible profit that can be achieved from the profit = total revenue - total
cost column is $2,300. This amount can be achieved by charging $90 per session and selling
50 sessions. This managerial decision maximizes profit.
Profit = Total Revenue - Total Cost = (P × Q ) – TC(Q) = (P × Q ) − (200 + 40Q). .
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
2
4. A typical university football program requires alumni to join one of several booster clubs
(each club gets seats in different parts of the stadium) before the person can buy season
tickets. What has this got to do with consumer surplus?
Answer: This pricing plan is a good example of two-part pricing. The football program can
increase its profits by using the two-part tariff to convert some consumer surplus into profits
or producer surplus. In addition to the per-unit price, the second price is the cost of joining
one of the booster clubs.
Blooms: Understand
Topic: Homogeneous Consumer Demands
5. Great Nuggets finds that there is a clear gender difference in the demand for their
chocolates. Men have very little price sensitivity and tend to buy whatever the sales clerk
recommends. Women, on the other hand, tend to ask many questions about product quality
and attempt to maximize the quantity available for the price. Great Nuggets would like to
implement a two-tier pricing system based on gender. What (nonlegal) problems would it
encounter?
Answer: The problem this firm would face is the resale of their candies—that is, women
buying candy for men in exchange for a cash transfer. The ability to price discriminate with
higher prices for more inelastic demanders is limited by the ability of consumers to engage in
resale.
Blooms: Understand
Topic: Price Discrimination—Heterogeneous Consumer Demands
6. Wet-n-Wild Indoor Water Park offers family fun year-round in the Northstar state to locals
and out-of-state visitors. The demand for day passes to the water park for each market
segment is independent of the other market segment. The marginal cost of providing service
to each visitor is $5 per day. Suppose the daily demand curves for the two market segments
are
(a) If Wet-n-Wild Indoor Water Park charges one price to all visitors, what is the profit
maximizing price? How many day passes will be sold per day?
(b) If Wet-n-Wild Indoor Water Park charges one price to locals, what is the profit
maximizing price for locals? How many day passes will be sold per day to locals?
3
(c) If Wet-n-Wild Indoor Water Park charges one price to out-of-towners, what is the profit
maximizing price for out-of-town guests? How many day passes will be sold per day to out-
of-town guests?
(d) Compare the prices from uniform pricing to the prices from price discrimination.
Answer: We add the two demand curves to get the market demand curve:
a.
b.
c.
4
d. Uniform pricing results in a price of $12.50. This price is higher than the price for locals
under price discrimination, $10. This price of $12.50 is lower than the price for out-of-town
guests under price discrimination, $17.50.
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
7. Two consumers, 1 and 2, of the same product have the following demand curves:
Q1 = 500 - 10P and Q2 = 500 - 20P. MC for the firm is $10. Calculate the prices when the firm
discriminates between the two consumers. Is this a good strategy, or should the firm charge
the same price to both of them?
Answer: First we have to derive the MR curves for both the consumers. So we first compute
the inverse demand curves. Given the demand curves, we have
10P = 500 - Q1 or P = 50 - 1/10Q1 and hence MR1 = 50 - 1/5Q1. Similarly,
20P = 500 - Q2 or P = 25 - 1/20Q2 and hence MR2 = 25 - 1/10Q2.
Now the amount that should be sold to the first consumer is found by setting MR1 = MC;
50 - 1/5Q1 = 10 or
1/5Q1 = 40 or
Q1 = 200 units. So price paid by this individual is 200 = 500 - 10P or P = $30.
So revenue extracted from this person is $6,000.
Now the amount that should be sold to the second consumer is found by setting MR2 = MC;
25 - 1/10Q2 = 10 or
1/10Q1 = 15 or
Q1 = 150 units. So price paid by this individual is 150 = 500 – 20P or P = $17.50.
So revenue extracted from this person is $17.50 x 150 = $5,125.
So the total revenue from this strategy is $11,125, from 350 units.
If the same price is set for both consumers, then the total demand curve is Q = 1,000 - 30P.
Or, by inverting the equation, we find P = 1,000/30 - 1/30Q and MR = 1,000/30 - 2/30Q.
So the right amount to sell to the market is found by setting MC = MR or
10 = 1,000/30 - 2/30Q
or 2/30Q = 700/30
or Q = 350 units. Now, P = 1,000/30 - 350/30 = 650/30 = $21.67, and hence TR = $4,081.
So setting different prices is better.
Difficulty: 03 Hard
Blooms: Analyze
AACSB: Analytic
5
8. P = 50 – 1/500Q is the demand curve for tickets. MC = $10 per ticket. What is the optimal
price? Calculate the consumer surplus at this price.
Answer: For the given demand curve, MR = 50 - 1/250Q. Setting MC = MR, we get
1/250Q = 40 or Q = 1,000 units, and so P = $48. So consumer surplus is = (1/2) x (50 - 48) x
1,000 = $1,000.
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
9. Tax Fighters, Inc., develops, markets, and sells software for tax preparation. Tax Fighters,
Inc. sells IRS Tax Fighter, a software for completing federal income tax forms and Gopher
Basher, a software for completing Minnesota state income tax forms. For simplicity, assume
that all of the costs in this industry are the fixed costs of developing the software packages
themselves. The marginal cost of producing another disk is approximately zero.
Consider the following information about the demand for tax software. There are an equal
number of consumers in each group. Figure 7.1 shows the maximum that each type of
consumer is willing to pay for each product. As vice president for pricing, explain your
optimal bundling and pricing strategy to maximize Tax Fighter profits from the sale of tax
software. Be sure to clearly explain why your strategy is.
optimal.
Answer: Group 2 consumers have very low willingness to pay. It is more profitable to try to
sell to Group 1 and Group 3 consumers. We can exploit the relative preference of Group 1
consumers for Tax Fighter and the relative preference of Group 3 consumers for Gopher
Basher through bundling the two products for $17.
If we priced each item individually, we could only charge $7 for IRS Tax Fighter in order to
entice 2/3 of the customers to buy the product. We could only charge $7 for Gopher Basher
and still have 2/3 of the consumers to buy Gopher Basher. However, we can get $17 in
revenue out of both Group1 and Group 2 customers by offering only a $17 bundle of both tax
programs, instead of the lower $14 of revenue we would receive from selling each program
separately. Let n be the number of customers in each group.
If P = $17, then TR = $17 x 2n = 34n.
If P = $7, then TR = $7 x 3n = 21n.
If P = $22, then TR = $22n.
So $17 is the best bundled price.
For nonbundled pricing
6
$7 for each product; then TR is $7 x 2n + $7 x 2n = 28n.

$4 for first and $3 for second; then TR is $4 x 3n + $3 x 3n = 21n.
So if n people are in each group, profits and total revenue are both maximized by charging
$17 for the two software products as a single bundle, given the firm’s extra revenue of 34n.
Difficulty: 03 Hard
Blooms: Analyze
AACSB: Analytic
Topic: Bundling
10. Give examples of block pricing, bundling, price discrimination and two-part tariffs.
Answer: Packing 75 toilet tissue rolls for $3.75 is an example of block pricing (as the
consumer pays $0.05 per roll, instead of maybe more on an individual basis). Packing a crest
toothbrush with a giant toothpaste packet is an example of bundling. Airline companies
selling tickets at a cheaper price for advance booking is an example of price discrimination.
Epcot center setting an entrance fee and then charging for certain rides is an example of two-
part tariffs.
Blooms: Understand
Topic: Homogeneous Consumer Demands, Price Discrimination—Heterogeneous Consumer
Demands, Bundling
Multiple Choice Questions
11. A firm with market power in pricing faces a

A. flat demand curve.
B. supply curve parallel to the horizontal axis.
C. downward-sloping supply curve.
D. downward-sloping demand curve.
Answer: D
Blooms: Understand
Topic: Pricing Objective
7
12. If a firm charges a price equal to the marginal cost—the competitive solution—then the
gains from trade are
A. all in the form of producer surplus.
B. split between producer and consumer surplus.
C. all in the form of consumer surplus.
D. split between shareholders and producers.
Answer: C
Blooms: Understand
13. The difference between what a consumer is willing to pay for a product and what she
actually pays when buying it is known as
A. consumer surplus.
B. the exchange rate.
C. the inflation rate.
D. price discrimination.
Answer: A
Difficulty: 01 Easy
Blooms: Remember
14. If Tiger Toys faces a demand curve of P = 85 − 0.25Q and a MC = ATC = 20, then the
market price would be
A. $85.00.
B. $52.50.
C. $130.00.
D. $32.50.
Answer: B
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
8
output would be
A. 65.0 units.
B. 85.0 units.
C. 130.0 units.
D. 32.5 units.
Answer: C
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
economic profits would be
A. $130.
B. $6,825.
C. $2,600.
D. $4,225.
Answer: D
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
markup would be
A. $52.50.
B. $20.00.
C. $32.50.
D. $65.00.
Answer: C
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
9
18. For decision-making purposes, fixed costs incurred by a firm with market power are
A. the same as variable costs.
B. not taken into consideration.
C. the same as marginal costs.
D. the same as opportunity costs of production.
Answer: B
Blooms: Understand
19. A firm’s market power decreases if the price elasticity of demand for its product
A. stays the same over time.
B. decreases.
C. equals the income elasticity of demand.
D. increases.
Answer: D
Blooms: Understand
20. Using the linear approximation system to estimate the profit maximizing price requires
that managers have information on the cost of production
A. and the nature of the production function.
B. the total population and the percentage of people in labor force.
C. the current price, the current quantity sold, and changes in price and quantity.
D. and the decision-making process of the marketplace.
Answer: C
Blooms: Understand
21. Using cost plus pricing, what is the price if ATC = $14.50 and the target rate of return is 4
percent?
A. $15.10
B. $49.34
C. $14.5
D. $22.10
10
Answer: A
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
22. Using cost plus pricing, what is the price if ATC = $23.50 and the target rate of return is
17 percent?
A. $28.31
B. $138.24
C. $29.38
D. $46.74
Answer: A
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
23. The cost plus pricing formula tends to ignore

A. incremental costs.
B. customer quantity sensitivity.
C. fixed costs.
D. quotas.
Answer: A
Difficulty: 01 Easy
Blooms: Remember
24. Calculate the markup price if MC = $10.00 and price elasticity equals 1.7.
A. $5.88
B. $17.24
C. $24.27
D. $32.42
Answer: C
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
11
25. The higher the price elasticity, the

A. more sensitive price changes are to quantity demanded.
B. less sensitive price changes are to quantity demanded.
C. more sensitive quantity demanded is to price changes.
D. less sensitive quantity demanded is to price changes.
Answer: C
Blooms: Understand
26. Many college basketball programs require alumni to join a booster club before they can
buy season tickets. This is an example of
A. a two-part tariff.
B. first-degree price discrimination.
C. block pricing.
D. cost-plus pricing
Answer: A
Blooms: Understand
27. A company might charge a customer different prices per unit, depending upon the number
of units purchased. This is called
A. bundling.
B. two-part tariff.
C. price discrimination.
D. block pricing.
Answer: D
Difficulty: 01 Easy
Blooms: Remember
12
28. Under block pricing, a company might

A. charge a customer different prices per unit, depending on the customer's loyalty.
B. charge a customer different prices per unit, depending on the number of units purchased.
C. provide a customer different units, depending on the price the consumer bids.
D. charge a customer different prices per unit, depending on the price the consumer bids.
Answer: B
Blooms: Understand
29. A customer pays an admission fee to get into the local YMCA and also a monthly
membership fee. This is called
A. bundling.
B. two-part tariff.
D. block pricing.
Answer: B
Difficulty: 01 Easy
Blooms: Remember
30. Price discrimination requires that different customers have different levels of price
sensitivity and that
A. the cost of production is different for every customer.
B. customers cannot resell the product amongst themselves.
C. demand is homogeneous amongst customers.
D. marginal costs are falling.
Answer: B
Difficulty: 01 Easy
Blooms: Remember
31. Price discrimination is usually defined as selling a product to different customers at

A. the same price even though costs of service are different.
B. different prices as costs of service are different.
C. the same price as costs of service are the same.
D. different prices even though costs of service are the same.
13
Answer: D
Difficulty: 01 Easy
Blooms: Remember
32. ______ extracts the maximum amount each customer is willing to pay for a product.
A. Personalized pricing
B. Group Pricing
C. Two-part tariff
D. Bundling
Answer: A
Difficulty: 01 Easy
Blooms: Remember
33. Third-degree price discrimination results when a firm sells

A. its product to every customer at a different price.
B. its product by volume at a different price.
C. every unit at the same price.
D. its product to different groups at different prices.
Answer: D
Difficulty: 01 Easy
Blooms: Remember
34. Many firms offer substantial rebates by mail or coupons for discounts at the point of sale.
The people who use the rebates or coupons have ______ than the people who don't use them.
A. greater price sensitivity
B. the same price sensitivity
C. lesser price sensitivity
D. inverted price sensitivity
Answer: A
Blooms: Understand
14
35. Disney sold The Little Mermaid for $20 with a $5 mail in rebate. The rebate should have
A. reduced overall customer demand.
B. stabilized overall customer demand.
C. increased overall customer demand.
D. inverted overall customer demand.
Answer: C
Blooms: Understand
36. Refer to Figure 7.2. If Happy Times Theater charges one price to all customers, then that
price will be
A. $6.25.
B. $7.50.
C. $10.00.
D. Not enough information available.
Answer: B
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
15
37. Refer to Figure 7.2. If Happy Times Theater charges one price to all customers, then the
profit will be:
A. $374.25.
B. $62.50.
C. $562.50.
D. $150.00.
Answer: A
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
38. Refer to Figure 7.2. If Happy Times Theater charges one price to day customers and a
different price to night customers, then the profit will be
A. $374.25.
B. $62.50.
C. $562.50.
D. $150.00.
Answer: C
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
16
39. Refer to Figure 7.2. If Happy Times Theater charges one price to day customers and
another price to night customers, then the day price will be
A. $7.50.
B. $5.50.
C. $6.25.
D. $10.00.
Answer: C
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
another price to night customers, then the night price will
be
A. $7.50.
B. $5.50.
C. $6.25.
D. $10.00.
Answer: D
Difficulty: 03 Hard
Blooms: Apply
AACSB: Analytic
17
another price to night customers, then its total profit on the sale of tickets will
A. increase.
B. stay the same.
C. decrease.
D. vary according to the slope of marginal revenue curve.
Answer: A
Difficulty: 03 Hard
Blooms: Analyze
AACSB: Analytic
42. Season tickets for sporting events are an example of

A. bundling.
B. two-part tariff.
D. block pricing.
Answer: A
Difficulty: 01 Easy
Blooms: Remember
Topic: Bundling
43. Which of the following is a reason for firms to bundle products?

A. To extract additional profit from a customer base with heterogeneous product demand
B. To extract additional profit by charging higher prices for the goods in a bundle
C. To clear the old stock of the product
D. To increase customer welfare and satisfaction
Answer: A
Blooms: Understand
Topic: Bundling
18
44. Electric generator companies did not raise their prices when there was a huge demand for
their products, due to a power shortage. The companies decided against a price rise because
they were
A. concerned about being sued by consumer activists.
B. concerned about political backlash.
C. concerned about peoples' welfare.
D. concerned about reputation and future demand.
Answer: D
Blooms: Understand
Topic: Other Concerns
45. Bio seeds offers free genetically modified seeds (GMS) to farmers in developing countries
the first season. The land accepts only GMS in any other cropping season. So providing free
seeds in the first season is a strategic way to
A. bundle goods.
B. administer a two-part tariff.
C. enforce price discrimination.
D. regulate future demand.
Answer: D
Blooms: Understand
46. Offering a product at a price below marginal cost is a more effective pricing strategy if
A. information costs are higher.
B. opportunity costs are higher.
C. sunk costs are higher.
D. information costs are lower.
Answer: A
Blooms: Understand
19
47. The Robinson-Patman Act limits the ability of the firms to

A. charge different prices to retailers.
B. produce certain products.
C. discriminate in terms of prices.
D. use capital-intensive means of production.
Answer: A
Difficulty: 01 Easy
Blooms: Remember
48. Implementation of a pricing strategy is complicated. Which of the following is a possible

reason?
A. Optimal pricing policies can change over time.
B. Firms change the technique of production over time.
C. Companies follow the recommendations of the Robinson-Patman Act.
D. Firms often do not differentiate their products.
Answer: A
Blooms: Understand
20
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Managerial Economics and Organizational Architecture 6Th Edition Brickley Test Bank Full Chapter PDF

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Organizational Architecture 6th Edition

$7 for each product; then TR is $7 x 2n + $7 x 2n = 28n.

Multiple Choice Questions

11. A firm with market power in pricing faces a

23. The cost plus pricing formula tends to ignore

25. The higher the price elasticity, the

28. Under block pricing, a company might

31. Price discrimination is usually defined as selling a product to different customers at

33. Third-degree price discrimination results when a firm sells

42. Season tickets for sporting events are an example of

43. Which of the following is a reason for firms to bundle products?

47. The Robinson-Patman Act limits the ability of the firms to

48. Implementation of a pricing strategy is complicated. Which of the following is a possible

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