Question

4. Derek is the owner of the only movie theater in town. By hiring several well-trained economists, Derek learns that the people watching movies after 8 P.M. have a much higher average willingness to pay than people watching at 5 P.M. The costs of showing a movie are identical at 5 P.M. and 8 P.M. To maximize his profit, what should Derek do? Give him some specific advice, including drawing him a diagram or two. (Derek can get his economists to interpret your diagrams as long as you label all the axes and all the curves.)

Answer 1

Derek should use the price discriminating policy in order to earn maximum revenue.

Price discriminating method is possible in this case because-

1. There are two separate identified groups of people with different demand for the same movie. Derek can identify people who have high willingness to pay as the group who watches movies at 8pm and people with low willingness to pay as the group who watches movies at 5pm.

2. There is no way that people can resale viewing the movie. In other words, people who watch the movie at 5 pm cannot resell the viewing of the movie for people at 8pm.

So, price discrimination is possible.

Now, we know that marginal cost remains constant and same for both groups.

The monopolist charges decides quantity where MC =MR.

The Price Derek charges at 5pm i.e. people with less willingness to pay is lower. (PL and QL)

The price Derek charges at 8 pm i.e. people with higher willingness to pay is higher.( Ph and Qh)

This allows Derek to convert some consumer surplus into profit.

So, price discrimination leads to lower consumer surplus and higher profits.