EC 219: Economics of the Firm

PROBLEM SET 2 – ON PRICE DISCRIMINATION

Q1. A software-maker is about to launch a software. Two versions of the software can be
manufactured: the “high quality version” at constant unit cost of 45, and the “low quality
version” at constant unit cost of 10. There are 200 potential buyers of the two versions of the
software: Z number of buyers are “high-value customers”, where Z is an integer between 80 and
120; the remaining buyers are “low-value customers”.
Each buyer has the following “maximum willingness to pay” for the two software versions:

high quality version low quality version

Each buyer’s net payoff from buying a software version is: {maximum willingness to pay for the
version – price paid}. When both versions are sold, consumer utility is maximized by choosing
that version for which the net payoff is the largest. One buyer will buy only one unit of one
version of the software, and a buyer will buy a version only if the net payoff is positive.
Price of each software version can only be set in multiples of five, i.e., every price must belong in
the set {5, 10, 15, 20, 25, …}.
(i) First, take the case where the government allows me to sell only one version of the software.
Fill in the blanks in the following statements:
In this case, the seller will maximize profits by selling only low-quality version at price
___________ whenever the number Z of high-value consumers is less than _________;
while the seller will maximize profits by selling only high-quality version at price ________
whenever the number Z of high-value consumers is more than __________.
The software-maker makes the following statements.
(ii) Next, take the case where the government allows me to sell both versions of the software.
Fill in the blanks in the following statements:
In this case, if Z = 100 then the seller will maximize profits by selling the low-quality version
at price _____________ and the high-quality version at price ___________; then the seller’s
total profits will be _____________________.

Q2. Cameras Inc. sells the 100-megapixel camera Centurion – which comes with its own
standard lens. Cameras Inc. can acquire each Centurion at a cost of Rs. 40,000. Each
Centurion can also be fitted with a fancy zoom lens – the Zoomer. While the general populace
can buy a Zoomer for Rs. 15,000, Cameras Inc. is in a position to acquire Zoomers at a price of
Rs.10,000 per lens.
There are two sets of consumers in town – two hundred Outdoor Photographers, and one
hundred Indoor Photographers. These consumers have the following “rupee values” for the
two products: {Centurion camera} and {Centurion + Zoomer}.

Centurion camera Centurion + Zoomer

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EC 219: Economics of the Firm

Each consumer acts according to the following rule: She buys that product for which the
difference {own rupee value of product – price paid} is strictly positive and strictly greater than
the corresponding difference for any other product.
Cameras Inc’s objective in choosing products to sell and in setting retail prices for the product(s)
is to maximize total profits. It can set Rupee prices of products only in integer values.
(i) First, consider the case where the Zoomer is unavailable in the market. In that case, what
price should Cameras Inc. set for the single product {Centurion camera}?
(ii) Next, consider the case where the Zoomer is available, but Cameras Inc. is required by law
to sell only one product – either the {Centurion camera} OR the bundle {Centurion + Zoomer}.
In that case, which product should Cameras Inc. sell and at what price?
(iii) Finally, consider the case where Cameras Inc. can sell either one or both of the products:
{Centurion camera} and {Centurion + Zoomer}. In that case, which product(s) should Cameras
Inc. sell and at what price(s)?

Q3. Publishers Inc. is about to bring out a book written by the author Mr. Anonymous.
Publishers Inc. is deciding on whether to print both hard-cover and soft-cover versions, or
only one version. The constant unit cost of the hard-cover version is 50, and that of the soft-
cover version is 40. There are 500 potential buyers of the book, of whom 200 are “fans” of
Mr. Anonymous. Each buyer has the following “valuations” for the two versions:

hard-cover soft-cover
A fan of Anonymous (200 buyers) 105 75
Not a fan (300 buyers) 70 60
Each buyer’s net payoff from buying a version is: {own valuation of version – price paid}.
Buyer utility maximization involves choosing that version for which the net payoff is largest.
Publishers Inc. knows the above “valuation distribution matrix”, but cannot identify a “fan of
Anonymous” by sight. Complete the following statements:
[Case I] If Publishers Inc. decides to sell only the hard-cover version, profit-maximizing
price will be ______________________ & total profits will be ______________________.
[Case II] If Publishers Inc. decides to sell only the soft-cover version, profit-maximizing
price will be ______________________ & total profits will be ______________________.
[Case III] If Publishers Inc. decides to sell both versions, profit-maximizing price of the
hard-cover version will be ____________________ and that of the soft-cover version will be
___________________, and the total profits will be _______________________________.

Can the three cases be “pair-wise compared” to determine who (e.g., the firm and/or a
specific consumer type) will be better off in one case as opposed to another?