EF3442 – Homework 3

Not For Distribution Beyond the Class

This homework is designed to test understanding of price discrimination.

No submission is required.

Question 1
The two main cities of the Republic of Ruritania are Streslau and Zenda.1 The population of each
city is 100,000. Citizens of the Republic consume Brawndo (the thirst mutilator) as if it were
water.2 The inverse demand curve of each inhabitant of Zenda is given by pZ = 120 − 2qZ . Here
pZ is the unit price of Brawndo (the unit of currency is called a florin) paid by a resident of Zenda
and qZ is the quantity supplied. Similarly, the inverse demand of each inhabitant of Streslau is
pS = 30 − 0.5qS .
The Brawndo Corporation is the monopoly supplier of Brawndo in Ruritania. It enjoys a constant
marginal cost of production of 0. It is trying to determine the best pricing strategy under a variety
of different scenarios. In each case assume there is no resale market for Brawndo, i.e., Brawndo
is purchased for personal consumption only. Assume, unless stated otherwise, that citizens in
Streslau cannot purchase Brawndo from Zenda, and vice versa.
1. If Brawndo can charge different unit prices in the different cities, what unit price should it
charge in each city to maximize total profit?

2. The Republic is contemplating regulation that would guarantee that all citizens of the Re-
public should pay the same price per unit for Brawndo. Were such a restriction in place,
what price should Brawndo set to maximize total profit? Brawndo is not obliged to serve
any particular city.

3. Are the citizens better off, as measured by consumer surplus, under this regulation compared
to part (1) above?

4. Now suppose that residents of Streslau can purchase Brawndo from Zenda by incuring a
total travel cost of 10 florin per unit and vice-versa. Under this condition how should the
1
Formerly a monarchy, the deposed king now serves as the doorman of Barribault’s Hotel.
2
It isn’t, but plants crave it. In fact, visitors to Ruritania who ask for water will frequently be shown the toilet.

1
 Brawndo Corporation set the price of Brawndo in Zenda and Streslau? For this part it can
set a different price in each city. Brawndo is not obliged to serve any particular city but it
cannot prevent residents of one city from traveling to the other to purchase Brawndo.

Question 2
Suppose Cyberdyne Systems creates a Professional version of its machine learning software. By
disabling some of the features in the Professional version it can create a Home version. Both
versions have zero marginal cost.
Cyberdyne Systems faces two customer segments each interested in buying at most one version.
The RPs of each segments for each version are displayed below.

Professional Version Home Version Segment Size

1. If Cyberdyne Systems offers only the Professional version, what price should it charge in
order to maximize revenue?

2. If it offers both versions, what prices should it set to maximize revenue.

3. Now suppose that instead of valuing the Home version at $0, each Business buyer values the
Home version at $80. Keep all other RPs the same as before. Show that at the prices you
chose in (2), Business buyers would actually prefer to buy the Home version instead of the
Professional version. Is this better or worse for Cyberdyne Systems than the single-product
strategy identified in (1)?

4. Assume Business buyers value the products as in part (3). Keep the Home version at the
same price as in part (2), but lowering the price of Professional version until the Business
buyers will be willing to buy the Professional version instead of the Home version. What
pair of prices will Cyberdyne Systems now be charging? What profits will it make? Is this
better or worse for the company than the single-product strategy described in (1)?

Question 3
The University of Ruritania bookstore is the monopoly seller of two types of books: one in eco-
nomics and another in mathematics. It acquires the books from suppliers for $35 each. Three
types of students are considering purchasing the books: students only majoring in math (M),
students only majoring in economics (E), and ones obtaining a double major (M & E). There are
an equal number of students of each type. Each student is interested in purchasing at most one
copy of each book. The RPs of each student of each type for each kind of book are displayed in
the table below.

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 math textbooks econ textbooks
M 60 10
E 10 60
M&E 46 46

1. What is the optimal price if the bookstore chooses individual pricing?

2. What is the optimal price if the bookstore chooses pure bundling? The RP of a bundle is the
sum of the individual RPs. Compared to individual pricing, which one will the bookstore
prefer?

3. What is the optimal mixed bundling strategy? The RP of a bundle is the sum of the
individual RPs. Which pricing strategy maximizes the bookstore’s profits?

Question 4
The Soylent corporation is in charge of dining options at the University of Ruritania. There are
two types of students, with demands given as follows:

eaters: q = 14 − p
p
grazers: q = 7 −
2
Here, p denotes the per meal price and q denotes the number of meals a month that a student will
purchase. The marginal cost of a meal is zero because it consists entirely of Soylent Green. There
are no capacity constraints. Soylent cannot identify a student’s type.

1. If Soylent can only sell meals individually, what price should it charge per meal to maximize
revenue?

2. A consultant suggests that Soylent should switch to a monthly meal plan instead of selling
by the meal. In a monthly plan, students pay a fee for the month and are free to consume
as many meals as they wish at no cost. Should they follow this advice? For this and all
subsequent parts, assume that there are 10,000 potential customers: 3,000 eaters, and 7,000
grazers.

3. Another consultant suggests that Soylent should offer a monthly meal plan in addition to a
per meal option at the rate determined in part 1. Should Soylent follow this advice?

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