A software company charges $200/month to businesses and $10/month to verified students for identical software. To maximize profit, the company should set prices so that:
AThe price difference equals the marginal cost of serving each group
BMarginal revenue equals marginal cost within each market segment separately
CEach group pays exactly its average willingness to pay
DThe higher-income group is always charged a price above the profit-maximizing monopoly price
This is third-degree price discrimination: the firm separates two identifiable segments (students vs. businesses) and sets MR = MC within each. Since MR = P(1 − 1/|ε|), the less price-elastic segment (businesses) faces a higher price. Option C describes first-degree discrimination, which requires knowing every individual's exact willingness to pay — impossible here. Option D is wrong; the price in each segment is determined by that segment's demand, not by a comparison to a uniform monopoly price.
Question 2 Multiple Choice
Under perfect (first-degree) price discrimination, compared to a single-price monopoly, which outcome holds?
ATotal output increases, consumer surplus is positive, and deadweight loss falls
BDeadweight loss is eliminated and all consumer surplus is transferred to the producer
CBoth total output and consumer surplus increase relative to the monopoly outcome
DThe firm earns the same profit but achieves a more equitable distribution
Perfect discrimination charges each buyer exactly their willingness to pay, so every unit where value exceeds marginal cost is sold — no deadweight loss. But consumer surplus is entirely extracted: every buyer pays their maximum, leaving them no better off than not buying. The social total surplus equals the competitive outcome, but it flows entirely to the producer. Option A is wrong because consumer surplus is zero, not positive. Option C is wrong because consumers are not better off — they pay their full reservation price.
Question 3 True / False
Price discrimination usually harms consumers relative to what they would experience under single-price monopoly.
TTrue
FFalse
Answer: False
Under a single-price monopoly, price-sensitive consumers are priced out entirely. If third-degree discrimination leads the firm to serve those consumers at a lower price (because it can now charge the inelastic segment more), those price-sensitive buyers are better off than under uniform monopoly pricing. Whether discrimination harms consumers on net depends on whether it expands or contracts total output and which groups face higher vs. lower prices.
Question 4 True / False
Successful price discrimination requires market power, the ability to prevent resale between buyer groups, and some mechanism to identify or induce separation of buyer types.
TTrue
FFalse
Answer: True
All three conditions are necessary. Without market power, competitors undercut the high price, eliminating the discrimination. Without preventing resale, low-price buyers resell to high-price buyers, arbitraging away the price gap. Without separating buyer types (through observable characteristics or self-selection mechanisms), the firm cannot charge different prices to different buyers. Remove any one condition and discrimination collapses.
Question 5 Short Answer
Why does first-degree price discrimination eliminate deadweight loss even though it exploits consumers maximally?
Think about your answer, then reveal below.
Model answer: Deadweight loss under single-price monopoly arises because consumers whose willingness to pay exceeds marginal cost are priced out — mutually beneficial trades don't happen. Under perfect discrimination, the firm charges each consumer exactly their willingness to pay, so every consumer with WTP ≥ MC makes a purchase. No beneficial trade is foregone, so deadweight loss is zero. The exploitation lies in how the gains are distributed — all surplus goes to the producer — not in whether the efficient quantity is traded.
Efficiency is about whether all mutually beneficial trades occur, not about distribution. Perfect discrimination achieves the competitive quantity (efficient) while capturing all surplus (maximally inequitable). This is why economists describe it as 'efficient but not equitable' — the total pie is as large as possible, but the consumer's slice is zero.