Practice Problems
Answer Key

1. Each person checking into a hotel in Russia is required to show proof of citizenship. The price for the room is set after the hotel knows what country a person comes from.

a. How can this practice be explained in terms of price discrimination?

Hotels figure out foreigners have higher ability to pay for a hotel room and are at the same time more restricted in the choices they have. Hence, they can tolerate a higher room rate.

b. Which type of price discrimination does this example illustrate?

Since the consumer are split in groups according to their demand elasticity, this is known as third-degree price discrimination.

2. a. List the conditions necessary for third-degree price discrimination.

· Presence of at least two groups with known demand differences;
· The ability of the firm to distinguish among those groups;
· The firm has to have some degree of market power;
· Possibility of resale has to be excluded.

b. It has been noticed that price discrimination is more common in the sale of services rather than in the sale of goods. Why? (Use your answer to part a as a reference. Which of the necessary conditions for PD listed there is more likely to hold for services than for goods?)

Services are hard to re-sell. How can one re-sell a haircut, dental work, or an advice of a lawyer? This fact makes it easier for firms to price discriminate.

3. Suppose you enter the store and see a sign on top of a shirt rack saying "Buy one, get second at 50% off".

a. Which type (degree) of price discrimination does this example represent?

Second-degree price discrimination - volume discounts.

b. Why does it make sense for the stores to price discriminate instead of charging the same price for each unit?

Price discrimination allows firms to set the prices for each unit somewhat closer to an individual's marginal utility from that unit than under uniform pricing. As a result, firms get a larger portion of the market surplus, leaving less of it to consumers.

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