Question

BestBuy plans to have an end of the season sale on videogames and High Definition TVs. After a focus group study, their marketing team found that they have four different types of customers, each with their own respective reservation price. The reservation prices are as listed below:

Customer	TV	Videogame
A	$1000	$500
B	$800	$450
C	$600	$375
D	$500	$300

For simplicity, assume that the marginal cost for producing any of these products is $0, and there is only one representative customer of each type.

(a) If BestBuy were to sell TV and videogames separately, what price should it set for each product in order to maximize its profit?

(b) BestBuy paid an outside consulting firm about its marketing strategy. The consultant recommended that BestBuy bundle TV and videogame as a package rather than selling them separately. Is the consultant correct? Why or why not? What is the profit of pure bundling? Is it higher or lower compared with the separate selling scenario in (A)? Are customers’ reservation prices of TV and videogames negatively or positively correlated?

(c) Suppose BestBuy has perfect information about the reservation price of each customer. It adopts a first-degree (perfect) price discrimination policy. What prices should it charge to maximize profit? What is the profit under this strategy? Is this higher than the profit in (a) or (b)?

please help Thank you

Answer 1

a) If BestBuy sets the price of TV at $1000, then customer A will only be able to buy TV. Thus profit would be $1000.

Similarly, if BestBuy sets a price of TV at $800 then customer A and B will only be able to buy TV. Thus profit would be $800*2 = $1600.

If BestBuy sets the price of TV at $600 then its profit would be $600*3 = $1800.

And if BestBuy sets the price at $500 then its profit would be $500*4 = $2000.

Therefore, in order to maximize its profit BestBuy should set a price of TV at $500.

If BestBuy sets the price of Videogame at $500, then customer A will only be able to buy Videogame. Thus profit would be $500.

Similarly, if BestBuy sets a price of Videogame at $450 then customer A and B will only be able to buy Videogame. Thus profit would be $450*2 = $900.

If BestBuy sets the price of Videogame at $375 then its profit would be $375*3 = $1125.

And if BestBuy sets the price at $300 then its profit would be $300*4 = $1200.

Therefore, in order to maximize its profit BestBuy should set a price of Videogame at $300.

Therefore its total profit = 500*4+300*4 =$3200

b) If BestBuy sells the bundle of TV and Videogame at a price of $1500, then customer A will only be able to buy TV. Thus its profit would be $1500.

If BestBuy sets the price of the bundle at $1250 then its profit would be $2500.

If BestBuy sets the price of the bundle at $975 then its profit would be $2925.

If BestBuy sets the price of the bundle at $800 then its profit would be $3200.

Therefore the maximum profit in pure bundling = $3200

Thus profit in pure bundling is same as compared with the separate selling scenario in (a).

Thus the consultant in not correct. Since both the strategies yields same profits.

And customers’ reservation price of TV and Videogame are positively correlated.

c) If BestBuy adopts a first degree price discrimination policy then it would charge:

customer A $1000 for TV and $500 for Videogame

customer B $800 for TV and $450 for Videogame

customer C $600 for TV and $375 for Videogame

customer D $500 for TV and $300 for Videogame

Therefore profit under this strategy = 1000+800+600+500+500+450+375+300 = $4525

It is higher than the profit in (a) and (b).