Question

A food co-op sells a homogenous good called groceries, denoted g. The co-ops cost function is described by: C(g) = F +cg; where F denotes fixed cost and c is the constant per unit variable cost. At a meeting of the co- op board, a young economist proposes the following marketing strategy: Set a fixed membership fee M and a price per unit of groceries pM that members pay. In addition, set a price per unit of groceries pN higher than pM at which the co-op will sell groceries to non-members.

1. What must be true about the demand of different customers for this strategy to work? (Hint: consider incentive compatibility)

2. What kinds of price discrimination does this strategy employ?

Answer 1

Solution:

So the co-op is selling grocery in two different ways.

a.Member ship fee M [Fixed]+ pM [Variable] - Two part tariff

b.pN [variable]

So it is dividing customers and charging them differently.So it is following 2.Third-Degree of Price Discrimination.

In the first strategy,the variable price is less thereby encouraging the customer to opt for it.But it will happen only when the membership fee(which is fixed) is such that the consumers feel/calculate that they can break-even.This strategy is used to capture the consumer surplus(i.e.,a situation when a consumer is able to purchase a product at price lower than the price he/she is willing and able to pay).And also they are committing the consumer to atleast buy the breakeven quantity (incentive comptibility).The price per unit(variable) is just marginally higher than the marginal cost.This is profit maximizing strategy.the co-op will encourage the consumers to opt for option 1 using this pricing technique.

The co-op in fact benefits more if the demand of consumers is different.

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