Question

Students are potential buyers of editing services for papers they write. Students A-G have Willingness-to-Pay for revisions as follows:

Student WTP($) A 15
B 13
C 11 D9 E7 F6 G4 H2

Suppose that the opportunity cost of editing is a constant $5 (MC=ATC=$5) and that there are many potential suppliers of editing services who are price-takers. What will the equilibrium price and quantity of editing services (how many papers will be edited at what price?). Why? What are consumer, producer and total economic surplus in this equilibrium.

Now suppose that you have been granted a monopoly in providing editing services. Suppose you must set a single price for everyone. .Find your marginal revenue schedule. Then use it to say what quantity of papers you will edit and what price you will charge to maximize profits. Explain. What will consumer, producer and total surplus be now? Compare to the competitive outcome.

Now suppose that you can practice perfect price discrimination. How many papers will you edit and what will your profits be? Explain. What are consumer, producer and total surplus now?

Finally, suppose that the WTP schedule above represents a single student’s WTP for successive papers edited during the semester. (He is willing to pay $14 for the first, $12 for the second, etc.) Your market consists of 100 students just like this one. Design a two-part pricing scheme that maximizes your profits. What fee will you charge and what price per paper edited? Explain.

Answer 1

A 15

B 13

C 11

D 9

E 7

F 6

G 4

H 2

Above are willingness of consumers to pay

ATC = MC = 5

Case 1)

If many seller are present, then Price = ATC = 5 (i.e. Zero Economic Profit)

In perfect competition, in the long run equillibrium, firms can only earn normal profit. (i.e. Zero Economic Profit)

Surplus for consumers will be as follows

A 15 - 5 = 10

B 13 - 5 = 8

C 11 - 5 = 6

D 9 - 5 = 4

E 7 - 5 = 2

F 6 - 5 = 1

Total CS = 31

Producer Surplus will be ZERO

Total Surplus = CS + PS = 31

Case 2)

If it is a monopoly.

Say monopolist charges 6. Then the profit will be 1 per unit. Units sold will be 6. Total Profit of 6.

Say monopolist charges 7. Then the profit will be 2 per unit. Units sold will be 5. Total Profit of 10.

Say monopolist charges 9. Then the profit will be 4 per unit. Units sold will be 4. Total Profit of 16.

Say monopolist charges 11. Then the profit will be 6 per unit. Units sold will be 3. Total Profit of 18.

Say monopolist charges 13. Then the profit will be 8 per unit. Units sold will be 2. Total Profit of 16.

Say monopolist charges 15. Then the profit will be 10 per unit. Units sold will be 1. Total Profit of 10.

So, to maximise profit,

monopolist charges 11. Then the profit will be 6 per unit. Units sold will be 3. Total Profit of 18.

Surplus for consumer will be as follows

A 15 - 11 = 4

B 13 - 11= 2

C 11 - 11= 0

Total CS = 6

Producer Surplus = 3*(11 - 5) = 18

Total Surplus = CS + PS = 24

Total surplus is less, becasue of underproduction. Loss in total surplus = 31 - 24 = 7

This 7 is termed as deadweight loss - loss to society because of underproduction.

Case 3)

Perfect price discrimination

Charge as per the willingness of the customer to pay > ATC

So, following consumers will be catered

A 15

B 13

C 11

D 9

E 7

F 6

Consumer surplus will be ZERO, as A will be paying 15, B will pay 13 and so on..

Producer surplus will be as follows (from respective consumers)

A 15 - 5 = 10

B 13 - 5 = 8

C 11 - 5 = 6

D 9 - 5 = 4

E 7 - 5 = 2

F 6 - 5 = 1

Total Producer surplus = 31

Total Surplus = CS + PS = 31

Case 4)

Two part pricing.

Fees should be equal to consumer surplus (capturing whole consumer surplus at one go)

Maximum willingness to pay for first printout is 15, while MC is 5

Each student will catered 6 times, till they are willing to pay greater than 5

So, Consumer surplus = 1/2*base*height = 1/2*6*(15 - 5) = 30

So, the one time fees charged for each consumer should be 30.

Also, set per paper price as MC i.e. 5.

Please like, this took a lot of time and effort.