Economics X Creativity
Multimedia Case 6: Two Idiots
Case Study prepared by:
Prof. Michael FUNG
Dr. Fred KU
Dr. David CHOW
Mr. Sam KONG
Miss Cindy LAU
Mr. Patrick CHEUNG
Video produced by: CUHK Business School (2012)
* Should you have any comment, please email Prof. Fung (creative.econ@cuhk.edu.hk)
P. 1
Introduction
What are the essential elements of university life? Apart
from studying, organizing students’ societies and
internship, international exchange is an indispensable
part for a university student. There were two brothers
studying at the Chinese University of Hong Kong:
Ricky and Jason. They were granted a chance for
joining an exchange programme in Manila. They were
excited and nervous since this was the first time for
them to step into a foreign country. The story covered
their preparations for the exchange journey. To solve the
housework problems, they decided to buy an allrounded maid first, there they met a shop-owner who possessed supernatural power…Then they
went to buy air tickets, where they had to choose between standard and standby tickets…Could
these two brothers go to Manila successfully?
The video introduces the concept of price discrimination
through the stories of Ricky and Jason. It explains how
the companies practice price discrimination in reality.
Apart from learning economic concepts, students can
learn a bit of the university life through this video.
Key Question
How to identify price discrimination in our daily life?
Key Concepts
1. Reasons for price discrimination
2. Types of price discrimination
3. Conditions for price discrimination
Learning Outcomes
Understand the practice of price discrimination and its effects on sellers and buyers.
P. 2
True / False Questions
1.
Price discrimination exists when identical goods are sold to different consumers at
different prices by a seller.
2.
Cinemas charge different prices to different groups of people because the marginal
costs of serving different groups are different.
3.
Under perfect price discrimination, consumer surplus will be fully captured by the
seller.
4.
Imperfect price discrimination occurs when some buyers pay more than their
maximum willingness to pay.
5.
If the cost of resale is low, price discrimination may fail.
6.
A competitive firm can price discriminate.
7.
Free discount coupons available to the general public can be a kind of price
discrimination.
8.
A monopolist that perfectly price discriminates creates no deadweight loss.
9.
When a monopolist charges a higher price, fewer goods will be sold.
10.
Price discrimination sometimes involves consumers to self-select into different price
packages.
MC Questions
1. Perfect price discrimination
A) reduces consumer surplus.
B) reduces the monopolist’s profits.
C) leads to an increase in deadweight loss.
D) reduces the number of consumers who are willing to purchase the monopolist’s
products.
2. According to the video, people with _______ and _______ price elasticity would
purchase _______ tickets for the same destination.
A) lower time cost; lower; standard
B) higher time cost; higher; standby
C) lower time cost; higher; standby
D) lower time cost; higher; standard
P. 3
3. Which of the following is/ are (an) example(s) of price discrimination?
(i) Students but not to adults are offered discount by the MTR for the same
journey.
(ii) The price charged to children under 8 is much lower than the regular price
for a buffet dinner.
(iii) A restaurant offers coupon and customers with coupon can enjoy the same
meal at a lower price.
A)
B)
C)
D)
(i) only
(i) and (iii) only
(ii) and (iii) only
All of the above
4. Price discrimination will only be possible if
(i) The market is separable into different submarkets with different elasticities
of demand.
(ii) Transaction cost of arbitrage of the product is high.
(iii) The seller has sufficient market power to influence the market price.
A) (i) and (ii) only
B) (ii) and (iii) only
C) (i) and (iii) only
D) All of the above
5. A firm cannot price discriminate if
A) buyers reveal only the price they are willing to pay for the product.
B) its marginal cost is constant for all levels of output.
C) it is in a perfectly competitive market.
D) it has a constant average cost.
6. In the video, the employment agent knows the individual demand curves of Ricky and
Jason. In order to fully capture the consumer surplus, she charges a price equals the
______ of each of them, and this is known as ______.
A) minimum willingness to pay; third degree price discrimination
B) maximum willingness to pay; first degree price discrimination
C) maximum willingness to pay; second degree price discrimination
D) maximum willingness to pay; third degree price discrimination
7. If a customer has to pay a lump sum fee before buying a good, which of the following
statements is FALSE?
A) This is known as third degree price discrimination.
B) This pricing arrangement may lead to an efficient output.
C) The maximum lump sum fee could be charged equals the customer’s original
consumer surplus.
D) Some of the consumer surplus will be extracted.
P. 4
8. Price discrimination sometimes increases social welfare in the form of
(i) increased total surplus.
(ii) reduced production costs.
(iii) increased consumer surplus.
A) (i) only.
B) (i) and (ii) only
C) (i) and (iii) only
D) (i), (ii), and (iii)
9. An airline knows that there are two types of travellers: business travellers and leisure
travellers. There are 150 seats available on the plane. For a particular flight, there are 100
business travellers who will pay $600 for a ticket, and there are 50 leisure travellers who
will pay $300 for a ticket. Suppose the cost to the airline of providing the flight is
$20,000, including the cost of pilots, flight attendants, fuel, etc. How much additional
profit can the firm earn by charging each customer their willingness to pay relative to
charging a flat price of $600 per ticket?
A) $15,000
B) $25,000
C) $40,000
D) $70,000
10. A monopolist’s profit with price discrimination will be
A) the same as if the firm charged a single, profit-maximizing price.
B) lower than as if the firm charged a single, profit-maximizing price
C) higher than as if the firm charged a single price because the costs of selling the
good will be lower.
D) higher than as if the firm charged just one price because the firm will capture
more consumer surplus.
P. 5
Discussion Questions
1. One way to price discriminate is to separate the market. The video uses MTR as an
example to illustrate price discrimination.
(a) According to the video, how does MTR separate students from adults?
(b) MTR recently offers “Ride 10 get 1 free” scheme to passengers who use Octopus
Card to take MTR journey at least 10 times from Monday to Friday in the same
week. Are passengers given a free-ride automatically? With reference to the
information on the MTR website, how to redeem the benefit?
(http://mtr.com.hk/eng/whatsnew/ride10_2012.html)
(c) Some customers are qualified for the free ride but they choose not to redeem the
free ticket. Suggest some possible reasons.
2. During lunch time, some fast food restaurants would offer discounts to secondary school
students. Students wearing secondary school uniform can enjoy the meals at a lower price,
while others are charged the regular price.
(a) Which type of price discrimination does it belong to?
(b) Assume there is a fast food restaurant which only offers one type of lunch box, the
“luncheon meat and eggs with rice” (餐蛋飯). The price of the lunch box for
secondary school students is $23 while the regular price is $35. What is the
maximum possible transaction cost if arbitrage is possible? Will price
discrimination be more profitable for the restaurant if arbitrage is possible?
(c) In reality, the fast food restaurant may offer students a free drink with purchase of
lunch box instead of discount. Is this price discrimination?
3. Suppose when Ricky and Jason discover that apart from the two types of economy class
ticket, they can also choose the first class tickets (of which better services, seats and food
will be provided).
(a) The price of a first class ticket is far higher than that of an economy class ticket.
Can the price difference between the tickets be fully justified by the cost difference?
(b) A direct flight of economy class from Hong Kong to Manila is often much more
expensive than the flight that requires transfer. Is this an example of price
discrimination?
(c) Ricky purchased a standard ticket to Manila a month before departure. Jason, one
day before departure, purchased the same ticket and found that he was charged at a
much higher price. Is this an example of price discrimination?
(d) Suppose Ricky went for a trip during the Lunar New Year holiday. Jason went for a
trip after the holiday and paid less for the air ticket. Can we infer who, Ricky or
Jason, has a more elastic demand for air travel?
4. Third degree price discrimination is common in our daily life. Give an example of third
degree price discrimination and explain how the seller separates the market into submarkets to price discriminate different customers.
P. 6
Challenging Question
5. In the video, there are two kinds of air tickets (standby and standard) to Manila. Suppose
there are two types of customers, one with low time cost and another with high time cost.
Other relevant information is tabulated below:
Maximum Willingness to Pay
Type
Cost to the seller Consumers with Consumers with
low time cost
high time cost
Standby
$1,000
$1,400
$2,250
Standard
$1,000
$1,600
$3,000
(a) According to the video, explain why Jason and Ricky would order the standard
ticket instead of the standby one. Which type of customers are they?
(b) Price discrimination refers to a situation where a seller sells the same product at
different prices to different consumers. Using the information from the video, what
are the similarities and differences between standby tickets and standard tickets?
(c) Suppose customers will choose the ticket that brings them a larger consumer
surplus. If the seller would like to separate customers by offering two types of
tickets, would charging a standby ticket $1,400 and a standard ticket $3,000 be
practical? (Hint: consumer surplus equals maximum willingness to pay less the
price)
Suppose now there are 100 customers who are going to purchase air tickets to Manila, of
which 30% have high time cost and the rest have low time cost. Let Pby and Pst be the
price of a standby ticket and a standard ticket respectively.
(d) Express the seller’s profit in terms of Pby and Pst, assuming that Pby and Pst are set
such that people with high time cost will purchase standard tickets, while people
with low time cost will purchase standby tickets.
(e) Customers with low time cost will purchase the standby tickets when the consumer
surplus obtained from the standby ticket (=$1,400 – Pby) is higher than that from
the standard ticket (=$1,600 – Pst). Rearranging the terms gives (Pst – Pby) > $200.
Following similar procedures, write down the condition such that customers with
high time cost will purchase the standard tickets.
(f) The seller can never charge a price beyond the maximum willingness to pay of the
customers, and thus we have Pby  $1,400 and Pst $3,000. If the seller would like
to use price discrimination to maximize its profit, what prices should be charged on
a standby and a standard ticket respectively? (Hint: Given constant cost, the higher
the price, the higher the profit, but subject to constraints in (e))
P. 7
Suggested Answers
True / False Questions:
1.T
2.F
3.T
4.F
5.T
6.F
7.T
8.T
9.T
10.T
MC Questions:
1.A
2.C
3.B
5.C
6.B
7.A
8.A
9.A
10.D
4.D
Discussion Questions:
1.
(a) If a student wants to enjoy the concessionary fares, he or she must activate the
student status on his or her Personalised Octopus card by returning a form
endorsed by acceptable institutions.
(b) No. Passengers need to redeem the free ticket on or before Sunday within the
same week at Customer Service Centres, designated counters at stations and MTR
Malls. Passenger can also get a redemption coupon from e-Instant Bonus
Terminals first and redeem the ticket at Customer Service Centres on or before the
following Sunday.
(c) There are many reasons for a passenger not redeeming the free ticket. For
example, he/she may not be taking MTR on a regular basis and thus find it
difficult to keep the travel record. In general, we can say that those are price
insensitive consumers, and the benefit of a free ticket is outweighed by the cost of
the time-consuming and tedious ticket redemption procedure. Notice that it is how
the MTR separates price insensitive passengers from sensitive ones.
2.
(a) It is an example of third degree price discrimination. Consumers are segmented
into different groups, namely, secondary school students and non- secondary
school students, and are charged different prices.
(b) Transaction cost must not exceed $12 for arbitrage to be possible.
If arbitrage is possible, price discrimination will not be more profitable as
students can resell the set lunch to other customers.
(c) Strictly speaking, the lunch box only is not price discriminating. However, the
free drink plus the lunch box is price discriminating.
3.
(a) No. The price difference is usually regarded as a result of pricing strategy to raise
profit.
(b) Yes. Given that the costs of offering direct flights and flights with transfer are the
same to the airline, passengers who are more price-sensitive and with lower time
cost are more likely to choose the flights with transfer.
(c) Yes. Other things equal, the two tickets can be regarded as the same product since
Ricky and Jason are having exactly the same flight service. As the two tickets are
sold at different prices to different consumers, it can be an example of price
discrimination.
(d) Jason
4.
A common example of third degree price discrimination is offering discounts to
elderly travelling on public transportation like MTR, bus, etc. The MTR company can
P. 8
differentiate consumers by asking them to present their identity cards when requested
or adopt an Elder Octopus Card.
5.
(a) As Jason and Ricky said in the video, they have high time costs, so they would
rather choose standard flight ticket.
(b) As a matter of fact, both types of ticket provide the same transport service.
However, standby ticket holders face uncertainty on the boarding time, and this
justifies the price difference.
(c) The table below shows the consumer surplus given the mentioned pair of prices:
Consumer surplus
Types of tickets
Low time cost High time cost
Standby
0
$850
Standard
-$1,400
0
If consumers are to maximise their consumer surplus, both types of consumers
will buy the standby ticket. Therefore, this set of prices cannot be used to separate
two groups of consumers.
(d) Total profit = 70(Pby-$1,000) + 30(Pst-$1,000)
(e) Condition that high time cost customers purchase standard ticket:
($3,000-Pst) > ($2,250-Pby)
Pst - Pby < $750
(f) Pst and Pby are subject to the following constraints:
$200 < Pst - Pby < $750, Pby  $1,400 and Pst $3,000
If Pst= $3000,
$200 < $3000 - Pby < $750
$2,800 > Pby > $2,250, which is greater than $1400 (the maximum willingness to
pay of the low time cost group) and therefore it is not practical.
If Pby = $1400,
$200 < Pst - $1,400 < $750
$1,600< Pst < $2,150, which satisfy the constraints.
*In short, Pby = $1400 and Pst= $2150 for profit maximisation
Total profit = 70($1,400-$1,000) + 30($2,150-$1,000) = $62, 500
Compare this profit level with the case where a single type of air tickets is offered:
Standby only: Pby = $1,400, profit = ($1,400 - $1,000) x 100 = $40,000
Standard only: Pst = $1,600, profit = ($1,600 - $1,000) x 100 = $60,000, or
Pst = $3,000, profit = ($3,000 - $1,000) x 30 = $60,000
Obviously the seller can earn a higher profit by separating the market using
different types of tickets.
*Pst should be a little bit lower than $ 2,150 in order to induce all the customers
with high time cost to buy standard tickets. As when Pst= $2,150 and Pby = $1,400,
the consumer surplus of buying standard and standby tickets to the customers with
high time cost are the same so they are indifferent to buying both types of tickets.
P. 9