Question

iHeartRadio is a streaming entertainment service that lets you listen to music, radio, and podcasts on different devices. It has three plans or options, starting with a free service up to an all-access service at $9.99 per month. From iHeartRadio’s perspective, the difference in the cost of service provision between each plan or option seems to be basically the same (it streams content to your device and automated software handles the different features between plans). How do you explain the variety of prices for virtually the same service, given that the cost to iHeartRadio of providing each plan is basically the same?

Select one:

a. iHeartRadio is making the common mistake of trying to maximize its profit margin instead of its total profit. Maximizing profit margin always results in a lower quantity supplied than maximizing total profit,and selling different plans will result in a lower quantity for each plan than if iHeartRadio sold a high quantity of a single service.

b. Price discrimination between demanders. High demanders are willing to pay a high price for a plan that includes playing songs on demand and listening offline. Low demanders aren't, and are only willing to pay a low price for a relatively smaller number of options.

c. The prices are different because it is more costly for iHeartRadio to set limits on what it allows to stream to individual devices under its free plan, and it is cheaper for iHeartRadio to just let all of its content stream under its all-access plan. The price difference is due to the cost difference.

d. Price discrimination between demanders. Buyers of the low-priced plan are high demanders since they are spreading out their demand for entertainment over fewer stations and options, so they value each single station or option relatively highly. Buyers of the more expensive plan are low demanders since they spread their entertainment demand over a large number of stations and options, and thus do not value each single station or option very highly.

Answer 1

Ans is D)

Because iheartradio is trying to exploit the varied elasticity of different segments of their customers through price discrimination. Though the marginal cost faced by iheartradio in providing various packs is basically the same but the customers they face vary on the outlook for demand. One segment which demands low priced plans is highly elastic - charging them lower price will make them demand more in quantity (thereby raising the total revenue via increases in quantity and more than overcoming the lower price). If instead iheartradio would have charged them high price, their quantity would have fallen much more than rise in price (because of highly elastic demand) and would instead have dragged total revenue down. On similar lines, buyers of expensive plans have inelastic demand (low demanders) and charging higher price won't reduce quantity to large extent and thereby increasing the total revenue. Thus, this price discrimination on the basis of varied elasticity of demand allow iheartradio to summon higher revenue.

Note that this price discrimination is only possible because iheartradio is carefully able to segment the section into the high demanders-low value pack and low demanders-expensive value pack.