Question

In: Economics

Pricing Strategies for Firms with Market Power — End of Chapter Problem The most popular movie...

Pricing Strategies for Firms with Market Power — End of Chapter Problem

The most popular movie streaming service is Netflix. Netflix members pay a monthly fee and are then entitled to stream as many hours of programming as they wish. You’ve been hired by Netflix to determine the profit-maximizing monthly fee. You estimate that each customer’s inverse demand for streaming is given by P=0.56−0.0112QP=0.56−0.0112Q, where Q is measured in hours of streaming time. (You may assume Netflix can provide an hour of streaming at essentially zero marginal cost.)

a. How many hours, Q, will each customer stream each month?

35

50

40

55

b. What is the most you should charge for a monthly Netflix membership?

$22

$14

$17

$20

Solutions

Expert Solution

(a)

This is like a second degree price discrimination. In which he will use demand equation to decide how many hours consumer will see and how much surplus they will receive.

In order to maximize profit under second degree price discrimination, he will produce that quantity at which P = MC and from that quantity amount of surplus consumer will receive, he will charge that as a membership or monthly fee.

Now, MC = marginal cost = 0 and P = 0.56−0.0112Q

Thus P = MC => 0.56−0.0112Q = 0 => Q = 50

Hence, the correct answer is (b) 50

(b)

Consumer surplus is the area below demand curve and above price line. Here P = 0.

Thus Consumer surplus = Area below above mentioned demand curve and below price line(P = 0)

Note when Q = 0, P = 0.56 and Area of a triangle = (1/2)* base* height

=> Consumer surplus = (1/2)(0.56 - 0)(50) = 14

Hence membership charged per subscription = $14.

Hence, the correct answer is (b) $14


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