Question

1. Give an example of a good or service that is commonly sold using second-degree price discrimination, and one that is commonly sold using third-degree price discrimination, besides the ones mentioned in the lecture and textbook. Be sure to provide enough information about how these goods are sold to make it clear that they are valid examples.

2. Using at least one graph, explain how it is possible that firms in a monopolistically competitive industry can have monopoly power, yet earn zero profits.

Answer 1

1. Second degree price discrimination refers to charging different prices for different units of quantities demanded. A common example of Second degree price discrimination is the bulk discounts that we often find in grocery stores. While 1 kg of flour is charged at say $1 per kg, if an individual buys 5 kg flour then she is charged $0.50 per kg. Another example is electricity tariffs which increase with the quantity of electricity consumed. Households consuming say up to 25 units are charged at $5 per unit and beyond that the tariff is $10 per unit of electricity consumed.

Third degree price discrimination occurs when sellers set prices based on certain demographic characteristics. Students are charged less than working professionals, senior citizen are given certain discounts as compared to other buyers when buying air tickets. This is an example of third degree price discrimination, the main aim of which is to bring those who otherwise would not have been able to afford the goods in the consumer base. The student discounts we avail in many cases is a classic example of third degree price discrimination.

2. In monopolistic competition firms sell differentiated products thereby acting as monopolists but there is no barrier to entry or exit of firms. Thus, when existing firms earn super normal profits in a monopolistic competitive industry, new firms will enter the market and this will continue till all firms start earning only normal profit, that is zero profit, in the long run despite having market power.