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Monopoly: Price Discrimination Conditions, Types, and Effects

10 questions

All types10Multiple choice5True / False2Matching3
Question 1Question →

A monopolistic airline operates on two routes: Route X, which is primarily used by business travelers with a price elasticity of demand of 0.60.6, and Route Y, which is primarily used by vacationers with a price elasticity of demand of 2.22.2. To maximize total profit through third-degree price discrimination, how should the airline set its fares on these two routes?

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Answer: Charge a higher fare on Route X and a lower fare on Route Y.

Answer

Charge a higher fare on Route X and a lower fare on Route Y.
Under third-degree price discrimination, a firm maximizes profit by charging a higher price in sub-markets with lower price elasticity of demand and a lower price in sub-markets with higher price elasticity of demand.

Step-by-Step Solution

1
Analyze the price elasticity of demand for each route
Route X has inelastic demand (∣ed∣=0.6<1|e_d| = 0.6 < 1) and Route Y has elastic demand (∣ed∣=2.2>1|e_d| = 2.2 > 1).
Price elasticity indicates consumer sensitivity to changes in price.
2
Apply the third-degree price discrimination profit-maximization rule
Equate marginal revenues across markets (MRX=MRY=MCMR_X = MR_Y = MC), where MR=P(1−1/∣ed∣)MR = P(1 - 1/|e_d|).
Because consumers on Route X are less price-sensitive, a higher price increases total revenue with a relatively small drop in quantity demanded.
3
Determine the relative pricing strategy
Set a higher price on Route X and a lower price on Route Y.
This allocation captures greater consumer surplus and maximizes overall monopoly profit.

Key Concept

Third-Degree Price Discrimination and Elasticity Rule
Question 2Question →

Match each degree of price discrimination on the left with its corresponding pricing strategy or market condition on the right.

Click a left item, then click its matching right item

Items

First-degree price discrimination
Second-degree price discrimination
Third-degree price discrimination

Matches

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Answer

First-degree price discrimination matches with charging each consumer their maximum willingness to pay; Second-degree price discrimination matches with charging different prices based on quantity blocks consumed; Third-degree price discrimination matches with charging different prices to distinct consumer groups based on price elasticity of demand.
First-degree price discrimination captures total consumer surplus by charging each individual buyer their maximum willingness to pay. Second-degree price discrimination uses tiered block pricing based on quantity consumed. Third-degree price discrimination segregates distinct consumer groups based on differing price elasticities of demand.

Step-by-Step Solution

1
Analyze First-degree price discrimination
First-degree price discrimination occurs when a monopolist charges every buyer the maximum price they are willing to pay.
This transfers the entire consumer surplus to the producer.
2
Analyze Second-degree price discrimination
Second-degree price discrimination involves tiered pricing or volume discounts depending on the quantity purchased.
Consumers self-select into pricing tiers based on block rates.
3
Analyze Third-degree price discrimination
Third-degree price discrimination separates buyers into independent sub-markets with distinct demand elasticities.
Higher prices are charged in market segments with lower price elasticity of demand.

Key Concept

Degrees and Mechanisms of Monopoly Price Discrimination
Question 3Question →

Under third-degree price discrimination, a profit-maximizing monopolist allocating output between two separated sub-markets with identical marginal costs will set a higher price in the sub-market exhibiting a higher price elasticity of demand.

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Answer: False

Answer

The statement is False. A profit-maximizing monopolist charges a lower price in the sub-market with higher price elasticity of demand and a higher price in the sub-market with lower price elasticity of demand.
The statement is false because the optimal pricing strategy under third-degree price discrimination requires charging a lower price in the sub-market where demand is more price-elastic and a higher price where demand is less price-elastic.

Step-by-Step Solution

1
Express Marginal Revenue (MRMR) in terms of Price (PP) and Price Elasticity of Demand (∣Ed∣|E_d|).
MR=P(1−1∣Ed∣)MR = P \left(1 - \frac{1}{|E_d|}\right)
This formula relates marginal revenue to product price and market elasticity.
2
Apply the multi-market equilibrium condition for a third-degree price discriminator.
MR1=MR2=MCMR_1 = MR_2 = MC
To maximize overall profit, marginal revenue earned from the last unit sold in each sub-market must be equal and matched to common marginal cost.
3
Equate the marginal revenue expressions for sub-market 1 and sub-market 2.
P1(1−1∣E1∣)=P2(1−1∣E2∣)P_1 \left(1 - \frac{1}{|E_1|}\right) = P_2 \left(1 - \frac{1}{|E_2|}\right)
This sets up the comparative pricing equation between the two markets.
4
Analyze the pricing relationship when ∣E1∣>∣E2∣|E_1| > |E_2|.
Since ∣E1∣>∣E2∣|E_1| > |E_2|, (1−1∣E1∣)>(1−1∣E2∣)\left(1 - \frac{1}{|E_1|}\right) > \left(1 - \frac{1}{|E_2|}\right), which requires P1<P2P_1 < P_2 for equality to hold.
A higher elasticity term yields a larger bracketed multiplier, meaning price must be lower in market 1.

Key Concept

Inverse elasticity rule in third-degree price discrimination
Question 4Question →

Which of the following is an essential condition required for a firm to successfully practice price discrimination?

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Answer: The firm must be able to prevent the resale of goods between sub-markets

Answer

The firm must be able to prevent the resale of goods between sub-markets.
For price discrimination to work, the seller must be able to keep the market segregated. If buyers in the low-price segment can resell the product to buyers in the high-price segment, the higher price cannot be maintained.

Step-by-Step Solution

1
Identify the basic prerequisites for price discrimination.
A firm requires monopoly power, market separation (prevention of seepage/resale), and differing price elasticities of demand.
Without market separation, buyers in the cheaper sub-market will resell to buyers in the expensive sub-market, eroding the price difference.
2
Evaluate the correct option against market principles.
Preventing resale ensures that buyers cannot engage in arbitrage between sub-markets.
Effective separation of sub-markets is an essential condition for sustaining price discrimination.

Key Concept

Conditions for Price Discrimination
Estimated Time:45s
Question 5Question →

A state-owned electric power distribution company operating as a monopoly charges domestic households a higher rate per kilowatt-hour than industrial factories. For this pricing policy to successfully increase the monopoly's total revenue, which condition regarding demand elasticity and market structure must hold?

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Answer: Domestic households must have a relatively price-inelastic demand, and seepage between the domestic and industrial sub-markets must be prevented.

Answer

Domestic households must have a relatively price-inelastic demand, and market seepage (arbitrage) between sub-markets must be strictly prevented.
For third-degree price discrimination to increase total revenue, the monopolist must charge a higher price in the sub-market where demand is relatively less price-elastic (inelastic) and ensure the sub-markets are separated so buyers cannot purchase in the cheaper market and resell in the dearer market.

Step-by-Step Solution

1
Identify the type of price discrimination described in the scenario.
Charging different prices to distinct consumer groups (domestic vs. industrial) based on market segmentation represents third-degree price discrimination.
The monopolist separates buyers into identifiable sub-markets rather than charging individual prices or block tariffs to single consumers.
2
Apply the price elasticity rule for third-degree price discrimination.
Higher prices must be assigned to the sub-market with lower price elasticity of demand (∣Ed∣<1|E_d| < 1), while lower prices are assigned to the sub-market with higher price elasticity of demand (∣Ed∣>1|E_d| > 1).
Inelastic demand means price increases lead to a smaller percentage decline in quantity demanded, thereby increasing total revenue in that sub-market.
3
Verify structural prerequisite conditions for successful discrimination.
The firm must possess monopoly power, sub-markets must be clearly separable, and arbitrage (seepage/resale) must be impossible.
If industrial buyers could resell low-cost electricity back to domestic consumers, the price differential would collapse.

Key Concept

Conditions for Third-Degree Price Discrimination
Estimated Time:1m 15s
Question 6Question →

A cinema operator charges adult moviegoers a higher admission fee while offering discounted ticket rates to students for the exact same movie screening. Which of the following conditions is essential for the cinema operator to successfully maintain this pricing practice?

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Answer: The price elasticity of demand for movie tickets must differ between the adult and student market segments.

Answer

The price elasticity of demand for movie tickets must differ between the adult and student market segments, and the monopolist must be able to prevent ticket resale between the two groups.
For a monopolist to successfully practice third-degree price discrimination, three primary conditions must be met: market power, effective separation of sub-markets (to prevent arbitrage), and differing price elasticities of demand between consumer groups. By charging a higher price to adult moviegoers (who have less elastic demand) and a lower price to students (who have more elastic demand), the cinema operator maximizes total revenue and profit.

Step-by-Step Solution

1
Identify the economic concept described in the scenario.
The cinema operator is practicing third-degree price discrimination by charging different prices to different customer groups for identical services.
Recognizing the market structure and pricing strategy sets up the necessary theoretical requirements.
2
Evaluate the key conditions required for price discrimination to be effective.
The seller must have monopoly power, sub-markets must be effectively separated to prevent arbitrage (resale), and price elasticities of demand must differ across sub-markets.
Monopolists maximize profit by charging higher prices in the market segment with less elastic (more inelastic) demand and lower prices where demand is more elastic.

Key Concept

Conditions for Monopoly Price Discrimination
Question 7Question →

A monopolist can successfully practice third-degree price discrimination between two separated sub-markets even if the price elasticity of demand is identical in both sub-markets.

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Answer: False

Answer

The statement is False. Differing price elasticities of demand between sub-markets are required for third-degree price discrimination.
The statement is false because a monopolist requires differing price elasticities of demand in separated sub-markets to charge different prices. When demand elasticities are identical, setting marginal revenue equal across sub-markets results in equal prices, meaning no price discrimination occurs.

Step-by-Step Solution

1
State the condition for profit maximization across separated sub-markets.
A monopolist maximizes total profit by setting marginal revenue in each market equal to marginal cost: MR1=MR2=MCMR_1 = MR_2 = MC.
Equating marginal revenue across markets ensures optimal allocation of sales.
2
Apply the relationship between price (PP), marginal revenue (MRMR), and price elasticity of demand (ee).
MR=P(1−1∣e∣)MR = P \left(1 - \frac{1}{|e|}\right).
This formula connects pricing power directly to market elasticity.
3
Evaluate the result when price elasticities of demand are identical (∣e1∣=∣e2∣|e_1| = |e_2|).
P1(1−1∣e∣)=P2(1−1∣e∣)  ⟹  P1=P2P_1 \left(1 - \frac{1}{|e|}\right) = P_2 \left(1 - \frac{1}{|e|}\right) \implies P_1 = P_2.
If elasticity is identical in both markets, the calculated profit-maximizing price is also identical, rendering price discrimination impossible.

Key Concept

Necessity of Differing Demand Elasticities for Price Discrimination
Estimated Time:45s
Question 8Question →

Match each degree of price discrimination with its corresponding pricing strategy or market characteristic.

Click a left item, then click its matching right item

Items

First-degree price discrimination
Second-degree price discrimination
Third-degree price discrimination

Matches

Show answer & explanation

Answer

First-degree price discrimination matches with charging each consumer the maximum price they are willing to pay; Second-degree price discrimination matches with charging different prices based on quantity blocks consumed; Third-degree price discrimination matches with charging different prices to distinct consumer groups based on price elasticity of demand.
First-degree price discrimination extracts all consumer surplus by charging individual maximum willingness to pay, second-degree varies rates according to quantity blocks purchased, and third-degree segments different consumer groups based on price elasticity of demand.

Step-by-Step Solution

1
Identify the characteristic of first-degree price discrimination
First-degree price discrimination captures maximum willingness to pay for each unit.
This form of pricing leaves zero consumer surplus for buyers.
2
Identify the characteristic of second-degree price discrimination
Second-degree price discrimination relies on pricing schedule variations by consumption blocks.
Prices decline as consumption volume increases across pre-set tiers.
3
Identify the characteristic of third-degree price discrimination
Third-degree price discrimination divides consumers into identifiable sub-markets.
Groups with relatively inelastic demand are charged higher prices, while groups with elastic demand receive lower prices.

Key Concept

Degrees of Price Discrimination
Question 9Question →

A software company operating as a monopoly sells its proprietary structural analysis software to both commercial engineering firms and academic institutions. The company sets a price of 1,200perlicenseforcommercialfirmsand1,200 per license for commercial firms and 300 per license for academic institutions, preventing any resale between the two consumer groups. Which of the following economic conditions justifies charging the higher price to commercial engineering firms under third-degree price discrimination?

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Answer: The price elasticity of demand for the software is relatively inelastic among commercial engineering firms compared to academic institutions.

Answer

The price elasticity of demand for the software is relatively inelastic among commercial engineering firms compared to academic institutions.
Under third-degree price discrimination, a profit-maximizing firm divides consumers into separate sub-markets based on differing price elasticities of demand. The firm charges a higher price in the sub-market with relatively inelastic demand because buyers there are less responsive to price increases, whereas it charges a lower price in the sub-market with relatively elastic demand.

Step-by-Step Solution

1
Identify the conditions governing third-degree price discrimination.
Third-degree price discrimination requires market power, clear segmentability into distinct sub-markets, prevention of resale (arbitrage), and differing price elasticities of demand across sub-markets.
A profit-maximizing monopolist equates marginal revenue across all sub-markets to its overall marginal cost (MR1=MR2=MCMR_1 = MR_2 = MC).
2
Relate pricing strategy to price elasticity of demand.
The relationship between price (PP) and price elasticity of demand (EdE_d) is given by MR=P(1−1∣Ed∣)MR = P(1 - \frac{1}{|E_d|}). Setting MR1=MR2MR_1 = MR_2 implies that the sub-market with lower elasticity (∣Ed∣|E_d|) yields a higher price.
Commercial firms have fewer substitutes and higher necessity for professional work, making their demand inelastic, allowing the firm to charge 1,200comparedto1,200 compared to 300 for price-sensitive academic institutions.

Key Concept

Third-degree price discrimination and sub-market elasticity pricing rule
Question 10Question →

Match each type or condition of monopolistic price discrimination on the left with its corresponding economic strategy or market characteristic on the right.

Click a left item, then click its matching right item

Items

First-Degree Price Discrimination
Second-Degree Price Discrimination
Third-Degree Price Discrimination
Prerequisite Condition for Price Discrimination

Matches

Show answer & explanation

Answer

First-Degree Price Discrimination matches charging each consumer their maximum reservation price. Second-Degree Price Discrimination matches block pricing based on quantity consumed. Third-Degree Price Discrimination matches segmenting markets by price elasticity of demand. The Prerequisite Condition matches market separation to prevent resale and arbitrage.
First-degree price discrimination captures all consumer surplus by charging each buyer their maximum willingness to pay. Second-degree price discrimination alters prices by consumption volume. Third-degree price discrimination separates groups by price elasticity of demand. Market separation is the vital condition that prevents resale across markets.

Step-by-Step Solution

1
Analyze First-Degree Price Discrimination
Identify that it targets individual consumer reservation prices to eliminate all consumer surplus.
By definition, perfect price discrimination extracts the entire consumer surplus from every buyer.
2
Analyze Second-Degree Price Discrimination
Identify that it uses quantity schedules and block rates.
Consumers choose their preferred tier based on consumption volume.
3
Analyze Third-Degree Price Discrimination
Identify market segmentation based on price elasticity of demand.
Groups with inelastic demand are charged higher prices, while groups with elastic demand receive lower prices.
4
Identify the key market condition for price discrimination
Identify prevention of resale (arbitrage) and market separation.
If buyers can resell the commodity, price discrimination collapses as low-price buyers sell to high-price buyers.

Key Concept

Monopoly Price Discrimination Degrees and Prerequisites
Monopoly: Price Discrimination Conditions, Types, and Effects Practice Questions — JAMB UTME | Examkin