Module 6 – QCT 6
BUSI620: Module 6 – QCT 6
Katrina Deloach
Liberty University
Dr. Kimberly Johnson
July 27, 2014
1
Question 13
What are (a) the advantages and (b) the disadvantages of cost-plus pricing? There are
several advantages of cost-plus pricing. First, “cost-plus pricing generally requires less information
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Salvatore’s Chapter 12
Question 7
Quantity discounts are not a form of price discrimination because the firm saves on
handling large orders. True or false? Explain. True, when it comes to price discrimination
according to Salvatore (2012), “three conditions must be met for a firm to be able to practice price
discrimination” (p. 492), and they are: 1. the firm must have control over price, 2. At different
times, for different groups, or different markets, price elasticity of demand must have different
quantities and, 3. Quantities of products, times used, and market for products must be separable
(pgs. 492-493). Therefore, quantity discounts are not a form of price discrimination.
Question 11
How is the transfer price of an intermediate product determined when (a) there is no
external market for the intermediate product. The transfer of price of an intermediate product is
determined when “1 unit of the intermediate product is used to produce each unit of the final
product, the outputs of the intermediate product and of the final product are equal” (Salvatore, 2012,
p. 502). (b) a perfectly competitive external market for the intermediate product exists, and “the
transfer price, however, depends on whether or not the external market for the intermediate product
is perfectly competitive” (p. 503). (c) an imperfectly competitive external market for the
intermediate product exists? “When an imperfectly competitive external market for the
intermediate product exists, the transfer price of the intermediate product for intrafirm sales will
differ from price of the intermediate product on the imperfectly competitive external market” (p.
505).
Problem 12
(a) Will a monopolist’s total revenue be larger with second-degree price discrimination
when the batches on which it charges a uniform price are larger or smaller? Why? Second
degree price discrimination according to Salvatore (2012) “refers to the charging of a uniform price
per unit for a specific quantity or block of the product sold to each customer, a lower price per unit
for an additional batch or black of the product , and so on” (p. 494). In this type of price
discrimination, monopolist’s total revenues will be larger because they are able to sell to bulk
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and less precise data than the rule of setting price at the output level at which marginal revenue
equals marginal cost” (Salvatore, 2012, p. 509). Second, “cost-plus pricing seems easy and simple
to use” (p. 509), third, cost-plus pricing usually results in relatively stable prices when costs do not
vary very much over time” (p. 509). Finally, cost-plus pricing “can provide a clear justification for
price increases when costs rise” (p. 509). Disadvantages of cost-plus pricing are criticized on
several grounds. One disadvantage is that “cost-plus pricing is based on accounting and historical
costs, rather than on replacement and opportunity costs” (Salvatore, 2012, p. 510). Another
disadvantage of cost-plus pricing “is based on the average, rather than on the marginal, cost of
production, and finally, cost-plus pricing “is criticized because it ignores conditions of demand” (p.
510). (c) Why is incremental cost pricing the correct pricing method? Incremental cost pricing is
the best/correct pricing method because, “it requires that direct and indirect changes in revenues and
costs resulting from a particular course of action be taken into consideration” (Salvatore, 2012, p.
512), and because it also provides firms with elasticity when they take into consideration both the
short-run and long-run implications of their pricing policies (p. 513). Why is full-cost pricing
equal to it? Full-cost pricing is equal to incremental cost-pricing because they both produce the
same results when a firm is manufacturing at their fullest capacity causing product’s cost to
decrease and sales to rise according to the writer’s comprehension.
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purchasers compared to single item purchasers at a higher unit price per unit. (b) How does a two-
part tariff differ from bundling? A two-part tariff differs from bundling in that, it “refers to the
pricing practice in which consumers pay an initial fee for the right to purchase a product or service,
as well as a usage fee or price for each unit of the product they purchase” (Salvatore, 2012, p. 541).
Bundling is common in tying. In bundling, “the firm requires customers buying or leasing one of
its products or services to also buy or lease another product or service when customers have
different tastes but the firm cannot price discriminate” (p. 515). In other words two-part tariffs
charges fees (usage) whereas, bundling requires customers to lease a second product when the need
arise but without price discriminating.
Spreadsheet problem 1 (p. 523) – SEE ATTACHED EXCEL FILE
Froeb et al.’s Chapter 14
Individual problem 14-1 (Barbie Dolls and Accessories)
Why might Mattel set a much lower contribution margin on its Barbie dolls than on the
accessories for the dolls? The reason why Mattel set a lower contribution margin on its Barbie
dolls than on the accessories for the dolls is because, if the company set the price of the dolls at a
lower price, it would give them the chance for a higher margin price for the accessories. This type
of pricing strategy works because “high-value doll users purchase more Barbie outfits” (Froeb et al.,
2014, p. 161). In addition, this kind of “metering” scheme according to Froeb et al. (2014) is used
to sell Barbie products: “you give away the dolls and sell the dresses at very high markups” (p.
161).
Individual problem 14-4 (Microwave Ovens)
If there is an equal number of men and women, what pricing strategy will yield the
greatest revenue? If there is an equal number of men and women, the pricing strategy that will
yield the greatest revenue in this scenario would be indirect price discrimination. According to
Froeb et al. (2014), “when a seller cannot directly identify who has a low or high value, the seller
can still discriminate by designing products or services that appeal to different consumer groups”
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(p. 158). Indirect price discrimination would yield the highest profit, because men and women
cannot be charged different prices for the same product. Both men and women will be charged $80
for a microwave without a defrost feature. However, pricing low to home users of microwaves
would produce profits as follows for men and women: price without defrost feature at $80, price
with defrost feature for men at $70 and for women at $150. Total profits would be 80+70=$150 and
80+150=$230. What if women compromise the bulk of microwave shoppers? If women
compromised the bulk of microwave shoppers, profits would be the highest at $230 compared to
men shoppers of microwave ovens at $150.
Salvatore’s Chapter 13
Question 8
What is the basic difference between using a subsidy to induce producers to install
antipollution equipment and a tax on producers who pollute? Taxes are the opposite of subsidies
(Froeb et al., p. 15). “Besides prohibition and regulation, and taxes and subsidies, negative and
positive externalities can sometimes be overcome by voluntary payments” (Salvatore, 2012, p. 550),
and pollution is an example of this. “If a firm pollutes the air and produces a foul odor, the
residents of the area can get together and contribute to the cost of introducing pollution-abatement
equipment by the firm” (p. 551). With that said, taxes help to overcome negative externalities and
subsidies are used to correct the externalities.
Question 10
Given the difficulties that the regulation of public utilities faces, would it not be better to
nationalize public utilities, as some European countries have done? In researching this question,
the writer elects to say no, it would not be better for the United States to nationalize public utilities
as some European countries have done because the prices of public utilities would fluctuate and be
higher. Another major difficulty with such policy is that it removes the economic efficiency in
supplying consumers with public utilities such as, “electric gas, water, and local transportation
companies” (Salvatore, 2012, p. 553). To avoid such conflict, the “local government usually allow
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a single firm to operate in the market but regulate the price and quantity of the services provided”
(p. 553). Nationalizing public utilities does not solve the efficiency problem that the United States
public utilities companies currently face.
Problem 12 (Justice Department)
Determine whether the Justice Department would challenge a merger between two firms
in an industry with 10 equal-sized firms, based on its 1984 Herfindahl-index guidelines only.
“According to its1984 guidelines, the Justice Department did not usually challenge a horizontal
merger during the 1980s and early 1990s if the post-merger Herfindahl index was less than 1,000”
(Salvatore, 2012, p. 561). Based on this information, in an attempt to answer this question, the
Herfindahl index is calculated as follows:
Herfindahl index = 10*10
= 100
The 100 is 10 hundreds times which equals a Herfindahl prior merger of 1000 (10*100).
Post-merger HHI with two firms merging leaves us with nine firms, with one firm merging at 20
percent and the remaining eight firms at 10 percent. See calculations below:
One firm = 202Eight firms = 102*8Herfindahl Index = 400+800
= 400 = 800 = 1,200
Based on the above calculations, and according to Salvatore (2012) which states, “if the
post-merger index was between 1,000 and 1,800 and the merger lead to an increase in the index of
more than 100, the Justice Department was likely to challenge the merger” (p. 561). That being
said, the writer believes that the Justice Department would more than likely challenge this merger
because there was a 200 point difference in the Herfindahl index (new HHI 1200 -1000 old HHI).
Problem 13 (Library research)
(a) Explain in what way the U.S. trucking industry exemplified the capture theory
hypothesis of government regulation prior to the passage of the Motor Carrier Act of 1980. The
U.S. trucking industry was regulated prior to the 1980 MCA by the Interstate Commerce
Commission (ICC). “The Motor Carrier Act of 1935 required new truckers to seek a "certificate of
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public convenience and necessity" from the ICC” (Moore, 1993, Para. 2). The U.S. trucking
industry exemplified the capture theory, also known as the economic theory of regulation
(Salvatore, 2012, p. 541), prior to the passage of the MCA, which, “only partially decontrolled
trucking” (Moore, 1993, Para. 12) in numerous of ways. (b) The result of the passage of the
Motor Carrier Act of 1980. As a result of the passage of the MCA, others companies entered the
market and with the help of the ICC, the 1980 MCA “freed the industry” according to Moore
(1993). Deregulating the U.S. trucking industry has improved tremendously since this time and has
“made it easier for nonunion workers to get jobs in the trucking industry” (Para. 15).
Problem 15 (Integrating Problem)
From the following figure referring to a natural monopolist, indicate (a) the best level of
output, price, and profits per unit and in total for the monopolist. Based on where MC intersects
with MR in figure 13-5, the best level of output is 6 units at $12. At a cost of $4 per unit, total
profits would equal to 24 million ($4*6 units). (b) the best level of output and price with a lump
sum tax that would eliminate all the monopolist's profits. If output does not change and lump sum
tax increases, there will be an increase in AC. However, MC would not change as lump sum taxes
are executed but the cost of output per unit would increase to $12. When TC and TR equals, there
are no profit losses in this scenario (c) the best level of output, price, and profits per unit and in
total with a $3 per unit tax collected from the monopolist. Because $3 per unit tax is a variable
cost, AC and MC will also increase by $3 which, based on Figure 13-5, increasing the taxes would
shift the curve to the left causing MC to cross MR at Q=5 and P=$8. Because of this, the quantity
in units decreases by 5 million while the best level of output price increases to $14 ($10+$4). Total
revenue (TR) is 5 million units*$14=$70. TC is $13*5=$65, Profits are, TR – TC (70-65) which
equals $5. Profits per unit per unit tax collected from the monopolist of $1 ($5 profits/5 million
units). (d) the best level of output and profit per unit and in total if the government sets the price
of the product or service at $ 10. The best level of output at a set price of $10, 8 units would need
to be sold for TR of $80 (10*8). At a quantity of 8, cost per unit is $7. Therefore, if we charge $10
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per unit, and our cost is $7 per unit, the profit unit is calculated as $10-$7=$3. Total profits
$3*8=$24 million. (e) Which is the best method of controlling monopoly power? Why? Based on
interpreting Figure 13-5, consumers get more quantity at a lower price, therefore, the writer believes
that regulating prices and setting maximums would be the best method of controlling monopoly
power because, it would benefit everyone involved compared to using a tax per unit method.
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References
Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial economics: a problem solving
approach (3rd ed.). Australia: South-Western Cengage Learning.
Moore, T. (1993). Trucking Deregulation. , by Thomas Gale Moore: The Concise Encyclopediaof
Economics. Retrieved August 2, 2014, from
http://www.econlib.org/library/Enc1/TruckingDeregulation.html
Salvatore, D. (2012). Managerial economics in a global economy (7th ed.). Oxford: Oxford
University Press.
