Questions for Critical Thinking 6
Questions for Critical Thinking Week 6
Busi 620 Managerial Economics
Liberty University
Salvatore Chapter 12
DQ 7) Quantity discounts are not a form of price discrimination because the firm saves on handling
large orders. True or false? Explain. This is a false statement. Quantity discounts, or volume pricing are
a form of second-degree price discrimination whereby customers are charged a lower price for purchasing
a large quantity of the same product. Both customers and producers benefit with lower costs involved.
DQ 8) a) Why are first- and second-degree price discrimination less common that third-degree
price discrimination? Charging different prices to different customers at different times, and for different
quantities for the same product describes price discrimination. Third-degree price discrimination is a very
common practice which happens when a product is sold in different markets. An example is a
manufacture who sells a product and also sells the product to a distributor. According to Salvatore, the
organization must have monopoly power, the price elasticity of demand must be different for each market,
and the market must be separate[Sal15]. However, first- and second-degree price discrimination is less
common. With first-degree discrimination, the firm has monopolistic control over the product and can
charge the highest possible price for each unit. According to Salvatore (2015), this type of discrimination
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is very rare because the firm must have knowledge of each consumer’s demand curve and charge
accordingly. Second-degree discrimination happens more often when a product can be metered, such as
public utilities, copy machines and computer rentals.
b) Are lower airline fares at midweek an example of third-degree price discrimination? Airlines
offering lower fares midweek do not meet the conditions for third-degree price discrimination. The fare is
sold in different markets, and they are separable as noted in third-degree price discrimination. However,
airlines do not have monopolistic control and the price elasticity of demand in different markets is
relatively the same in different markets,
c) Under what conditions would it not be useful to charge different prices in different markets (i.e.,
practice third-degree price discrimination) even if possible? If the price elasticity of demand is the
same in different markets, then it would not be useful to charge different prices.
DQ 13) What are a) the advantages and (b) the disadvantages of cost-plus pricing? (c) why is
incremental cost pricing the correct pricing method? Why is full-cost pricing equal to it?
a) Cost-plus pricing is the most common form of pricing products. It is also called mark-up pricing and
full-cost pricing[Sal15]. The advantages of cost-plus pricing include the need of less information to set
the price, the ease of use, the stability of the price over time, and the justification of a price increase when
costs rise[Sal15].
b) One of the biggest disadvantages to cost-plus pricing is the use of this method to properly estimate
total variable costs, and the allocation of overhead costs to the various products produced by a business.
While not necessarily disadvantages, some criticisms to this method include the use of historical costs to
set pricing, using average costs instead of marginal costs, and not taking into account conditions of
demand[Sal15].
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c) Incremental cost pricing is pricing based on an incremental analysis which can determine whether the
increase in total revenue derived from any changes a firm make is greater than the total cost after
covering overhead and fixed costs[Sal15].
d) Full cost pricing is equal to incremental pricing when production is at capacity and lowering a
product’s price or introducing a new product causes all costs, including plant and equipment, to
increase[Sal15].
Problem 5) The Dairy Farm Company, a small producer of milk and cheese, has estimated the
quantities of milk and cheese that it can produce with three levels of total expenditures or total
costs. These are indicated in the following table. If the price of milk (product A) and the price of
cheese (product B) that the firm receives are $1 each per unit of the products, draw a figure
showing the maximum total profit (π) that the firm can earn at each level of TC and the overall
maximum profit that the firm can earn for the three different levels of TC.
****See Attached Excel with formulas in cells*******
TC = 70
Product AProduct RevenuProfit
B e
80 0 80 10
70 40 110 40
50 70 120 50
20 90 110 40
0 95 95 25
TC = 90
Product AProduct RevenuProfit
B e
100 0 100 10
90 60 150 60
70 90 160 70
30 120 150 60
0 130 130 40
TC = 140
Product AProduct RevenuProfit
B e
130 0 130 -10
110 70 180 40
80 120 200 60
40 150 190 50
0 160 160 20
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For the first level where TC = $70, the maximum level of profit that can be earned is $50.
At the second level where TC = $90, the maximum level of profit that can be earned is $70.
At the third level where TC = $140, the maximum level of profit that can be earned is $60.
The overall maximum profit that can be earned is $70 when the TC is $90.
Froeb et al. Chapter 14
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? Mattel’s lower contribution margin means their selling price is very close to the cost to
produce, or the average variable costs. Mattel knows that it will make more revenue from selling
accessories for the Barbie dolls. Besides clothing and shoes, Mattel also sells Barbie houses, cars, pets
and other accessories.
14-4 Microwave Ovens
A manufacturer of microwaves has discovered that male shoppers have little value for microwaves
and attribute almost no extra value to an auto-defrost feature. Female shoppers generally value
microwaves more than men and attribute greater value to the auto-defrost feature. There is little
additional cost to incorporating an auto-defrost feature. Since men and women cannot be charged
different prices for the same product, the manufacturer is considering introducing two different
models. The manufacturer has determined that men value a simple microwave at $70 and one with
auto-defrost at $80 while women value a simple microwave at $80 and one with auto-defrost at
$150. If there is an equal number of men and women, what pricing strategy will yield the greatest
revenue?
To derive the greatest revenue, the regular microwave should be priced at $70, and the microwave with
the auto-defrost should be priced at $139. The pricing of $70 is the best price point for the men. For the
women, who value the microwave more, there would be a surplus value of $10 for the purchase of the
regular microwave, and a surplus value of $11 if the microwave with auto-defrost was purchased.
[$10 = $80 (value) - $70 (price).
[$11 = $150 (value) - $139 (price)
What if women comprise the bulk of microwave shoppers? While women will pay $150 for the
microwave, the company will run the risk of cannibalization of sales if it charges the full price because
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two kinds of the same model are produced. As Froeb et al., (2016, p. 174) states, it is not always
profitable to use price discrimination. The microwave with auto-defrost should remain priced at $139.
[150 (Auto defrost unit value) - $80 (Regular unit value)] = $70. The difference in price between the two
models must be less than $70. So, $70 for regular unit and $70 + $69 = $139.
Salvatore Chapter 13
DQ 8). What is the basic difference between using a subsidy to induce producers to install
antipollution equipment and a tax on producers who pollute? A subsidy is a form of aid from the
government to help an industry or business offset an economic loss. Salvatore describes the subsidy as a
type of government regulation that is used to “overcome market failures”[Sal15]. A tax is an enforceable
cost levied against a business.
DQ 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? Explain your answer. While
nationalizing public utilities sounds like a good idea, it would be a better idea to deregulate the public
utility companies. About half of the public utility companies in the U.S. have been deregulated which lets
customers compare rates and choose their power company[Sal15]. Just as nationalization removes
incentives to operate efficiently and hold costs down, regulated public utilities operate as natural
monopolies and have very little competition. As Salvatore (2015, p. 568) states, “regulation can lead to
inefficiencies.”
Problem 12.) 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.
Ten equal-sized firms - H = (102) x 10 = 1000
A merger between two firms - H = [(102 x 8)] + (202) = 800 + 400 = 1200
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The merger would create a 200-point increase on the Herfindahl-index. The Justice Department would
probably challenge the merger. If the Herfindahl-index was less than 1000, and the product line was the
same, the Justice Department would not challenge a horizontal merger. However, if the Herfindahl-index
was determined to be between 1000 and 1800 after the merger, and the index increased by more than
100 points, or by 50 points after reaching 1800, then the Justice Department would challenge the
merger[Sal15]. There are some exceptions to challenging mergers; if the acquisition prevented the failing
of the firm, the entry into the industry was easy, there was strong foreign competition, and the acquisition
led to an increased “economies of scale”[Sal15].
Problem 13.) (Library research)
(a) 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 term “capture theory” was
coined by economist George Stigler who discovered that monopolies are created and regulated by the
demand of the producers in the industry. The producers “capture”, or control the regulatory agency and
use regulations to keep out competition[Anond2]. Prior to the deregulation of the trucking industry in
1980, the Interstate Commerce Commission (ICC), under the control of the Teamsters Union and the
American Trucking Association, regulated the monopolization of the trucking industry. The effect reduced
competition and caused it to be inefficient. Truckers had to purchase rights to carry certain products and
could only use certain delivery routes.
(b) the result of the passage of the Motor Carrier act of 1980. The passage of the Motor Carrier Act of
1980 partially deregulated the trucking industry by mandating the ICC eliminate restrictions on what
goods could be carried, routes that could be used, and the locations that could be served. Further, truckers
were given the ability to increase and decrease prices at their discretion, called a “zone of
reasonableness”. The effect of the deregulation of this industry has been favorable, as pricing fell around
20%, service quality improved, truckers were more willing to negotiate pricing and non-union truckers
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were able to enter the industry. This act also impacted businesses, as they no longer needed to keep large
inventories on hand[Moond].
Problem 15). Integrating Problem. From Figure 13-5, referring to a natural monopolist,
(a) indicate the best level of output, price, and profits per unit and in total for the monopolist
The best level of output is where marginal cost intersects with marginal revenue at point E. At this point,
Q = 6, or 6 million units.
For the best price, a monopolist would charge $12. This is found at the intersection of AC and D, which is
point A.
To determine the profit, the AC, or average cost, is needed. Moving up from Q = 6 (point E), point AC is
at $8. Profit is determined by P – AC. $12 - $8 = $4/unit.
Total profit equals $24 million ($4 x $6 million)
(b) the best level of output and price with a lump sum tax that would eliminate all the monopolist’s
profits
The lump sum tax is a fixed cost, therefore it affects the (AC) average cost, but not the marginal cost. The
tax causes the (AC) to rise by $4, where it is equal to (P) price. There are no profits.
(c) the best level of output, price, and profits per unit and in total with a $3 per unit tax collected
from the monopolist
Since an increase in taxes of $3 per unit causes both the (MC) and (AC) to rise, the output decreases to Q
= 5. The price will rise to point A, or $13/unit. The (AC) will also rise to $13 from point B ($10/unit).
With MR at $13, and AC also at $13, there is no profit.
(d) the best level of output and profit per unit and in total if the government set the price of the
product or service at $10
With the price set at $10 for the product or service, the monopolist will set the output level to Q = 8, or 8
million. This is determined on the diagram by the intersection of P = MC. The P =AC would be $8. The
profit for each unit would be (P – AC), or $10 - $8 = $2.
(e) Which is the best method of controlling monopoly power? Why?
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References
Anonymous. (n.d.). George J. Stigler. Retrieved from Library of Economics Liberty:
http://www.econlib.org/library/Enc/bios/Stigler.html
Moore, T. G. (n.d.). Trucking Deregulation. Retrieved from Library of Economics and Liberty :
http://www.econlib.org/library/Enc1/TruckingDeregulation.html
Salvatore, D. (2015). Managerial Economics In a Global Economy (3 ed.). Oxford, UK: Oxford
University Press.
Option (d) is the best method of controlling monopoly power because it shows a reasonable rate of return
on its investment while producing the greatest level of output.
