Question

Suppose a consumer’s demand function for a bar of chocolate produced by your firm is given by P=1-0.2Q. The firm’s cost is represented by the cost function of C(Q) = 0.2Q (assuming constant marginal cost and zero fixed cost).

(a) Under the normal uniform pricing strategy, what are the profit-maximizing quantity,

price, and profit?

(b) How can you increase your profit by block pricing/package deal? Show the solution

graphically.

(c) Despite your answer in (b) above, what are the possible reasons why the suppliers

might still charge a uniform price rather than using other pricing strategies?

(d) “A way to extract buyer surplus is to use block pricing, but when we observe block pricing in the real world, we should not conclude immediately that it is adopted for the purpose of extraction of buyer surplus.” Explain the meaning of this statement.

Give some real-world examples to illustrate your explanation.

Answer 1

a and b solved in detail in attached image.

(c). A firm may prefer uniform pricing despite more profit from other strategies because the consumers value the sense of fairness in pricing and this might lead to increased brand value of a product, increasing the profits furthur even in uniform pricing. (There is a lot of research available corroborating this. You can even cite articles in your answer showing this results of this research.)

(d). The block pricing can be used in services such as electricity whereby the electicity rates are in accordance with the block pricing strategy. For instance, a different price for first few units and then a higher price for using more units.

This is not necessarily done for profit maximization. The goal here is to discourage people from more electricity consumption and to save energy resources.