HOMEWORK 7

You will need
(i) The number of high value and low value students, and nonstudents
(ii) The transaction prices
(iii) The (stated) cartel prices
(iv) In 7.3 and 7.4, the level of student sales

Sellers had a marginal cost of *5.

1. Draw the demand curve.  Theoretically, what price maximizes profit?  

2. What does the supply look like?  Add it to your graph in another
color.  Shade the region equal to the profit at the price which maximizes
profit.

3. Compute the profit at a price of *10, *15, and *20.  How did actual
profits in experiment 7.1 compare?  How would you explain the difference?
(Please don't write a lot for the last part - a couple of lines is fine.)

4. What was the cartel's agreed-on price(s) in 7.2?  Did they sell for
less?  Compute the average price charged.

5. Draw the demand and supply for experiment 7.2.  What is the
theoretical equilibrium price?

6. Were actual prices significantly above this equilibrium?

7. Compute the (theoretical) total profits of sellers for the following
prices:

      Price for      Price for
      nonstudents    students
(a)        10            10
(b)        15            10
(c)        15            15

Why is it profitable to charge students a lower price?

8. A rule of thumb is that sellers should charge lower prices to
consumers with more elastic demand.  Why is this the case?

9. U.S. pharmaceutical companies charge much less in Mexico than in the
    U.S. for the same drug.  Why is this price discrimination profitable
    for them?

10. Did the sellers in your experiment 7.3 find the profit-maximizing
    prices?

11. In experiment 7.4, did sellers offer discounted prices to students?

12. In some groups, students in experiment 7.4 could buy at the lower 
price and sell to others.  Did anyone buy at a higher price?  Why?

Food for thought (not graded):

13. Buying at the low price and reselling at a higher price is called
arbitrage.  Comment on the following statement: 

  "If sellers can't prevent arbitrage, the sellers might as well charge
   one price, because all transactions will occur at the low price."

14. What was the (theoretical) profit-maximizing price in experiment 7.4?
    (Hint: if all sales are at the student price, what should that price
    be?)

15. Airlines attempt to charge higher prices to business travellers and
lower prices to tourists.  How do they prevent arbitrage? (Hint: Are
business travellers less flexible about staying over Saturday night?) 

Check on your understanding of externalities.  You should be able to 
answer the following question.

1(i): Draw the private marginal cost, private marginal value, and
social marginal value for a good with a positive externality. Use smooth
curves. Identify demand and supply, and the quantity that arises with no
intervention, and the socially optimal quantity. Shade the region which
represents the dead weight loss when no subsidy is used.

1(ii):In a separate figure, identify the size of the per unit subsidy needed to
induce the socially efficient quantity.