Question

3. A small town has only one doctor. He charges a rich person twice as much as a poor person for a similar consultation.

a) How does this pricing policy relate to the price elasticity of demand? Are resources being used efficiently? Explain.

b) Suppose now that the doctor charges everyone the maximum price they would be willing to pay. What happens to consumer surplus? Will resources the allocated efficiently in this case? Explain and illustrate your answer with a graph

Answer 1

3. There is only one doctor so the market is a monopoly. Monopolist charges a rich person twice as much as a poor person for a similar consultation.

a) This pricing policy relate to the price elasticity of demand because rich are less sensitive to price changes so that their demand is inelastic. The revenue maximizing rule indicates that monopolist should charge a higher price from consumers with less demand elasticity. Similarly poor are more sensitive to price changes so that their demand is elastic. The revenue maximizing rule indicates that monopolist should charge a lower price from consumers with higher demand elasticity

The resources are not being used efficiently because the price is not equal to the marginal cost of providing the consultation but it varies with elasticity of demand.

b) Doctor charges everyone the maximum price they would be willing to pay. This implies that the lowest price charged is the marginal cost. In that case, there will be no consumer surplus since it is extracted by the monopolist when it charges each consumer pays the maximum she can. Here the resources are allocated efficiently because the last price charged is same as marginal cost.