Question

In: Economics

You sell chairs; they cost your $20 each to produce and sell. In your world there...

You sell chairs; they cost your $20 each to produce and sell. In your world there are 7 potential buyers for your chairs, listed below: (Each person will buy a maximum of 1 chair each.)

Buyer                          Reservation Price

Craig                           $50

Bill                              $40

John                            $30

Hank                           $25

Sally                            $19.95

Mophead                     $15

Scaredycat                  $10

  1. Calculate the profit-maximizing quantity of chairs and total profits if you use 1st degree price discrimination. (You are a psychic.)

b) Calculate the profit-maximizing quantity of chairs and total profits if price discrimination is banned by government (and you are a law-abiding citizen).

Solutions

Expert Solution

In this scenario, we assume that seller is aware of buyers' reservation prices

a)

In this case, each buyer will be charged at a price equal to his/her reservation price as long as Reservation price is higher than or equal to marginal cost. Following schedule can be made with the help of information given

Buyer Reservation price=Sale price=P Profit=P-MC i.e. P-$20
Craig 50 30
Bill 40 20
John 30 10
Hank 25 5
Total 65

Reservation price is higher than marginal cost in the case of first 4 buyers only. Firm will sell 4 units only to maximize profit. Total profit at this level is $65

b)

In this case,

Suppose firm sets price =$50

Firm is able to sell only one unit. Total profit=Q(P-MC)=1*(50-20)=$30

Suppose firm sets price =$40

Firm is able to sell two units. Total profit=Q(P-MC)=2*(40-20)=$40

Suppose firm sets price =$30

Firm is able to sell three units. Total profit=Q(P-MC)=3*(30-20)=$30

Suppose firm sets price =$25

Firm is able to sell four units. Total profit=Q(P-MC)=4*(25-20)=$20

We can see that profit is maximized when firm charges a price of $40 per chair. At this price, 2 units will be sold. Optimal profit is $40

Rahul Sunny answered 1 year ago
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