Question

1. What is price discrimination and why is i possible? 2. Explain the following: a. substitution effect b. income effect c. diminishing marginal utility

Answer 1

1)Price discrimination is a pricing strategy a monopolists uses to maximizes his profit.There are three kinds of price discrimination

1)First degree price discrimination-In this type of discrimination the monopolists get the maximum profit because it charges the price similar to the amount the customer is valuing the product.

2)Second degree price discrimination-This type of discrimination occurs when a monopolists charges different prices for different quantities consumed.

3)third degree price discrimination-It is possible when there are two separate markets for a product and no arbitrage possible.The market which has high elasticity of price has less price and the market with lower elasticity has higher price.

Price discrimination is possible because of geographical separation of two markets, government regulation,no arbitrage and different elasticities for goods.

2)a) Substitution effect occurs when demand of a good A changes due to change in its relative price.For example when price of coca-cola increases then demand for pepsi which is substitute for coca- cola increases because it pepsi has become relatively cheaper than coca-cola

b)Income effect-Income effect occurs when price decrease of a product leaves more real income to the consumer to make choices of demand.For example in two commodity space of coke and pepsi ,when price of pepsi decreases, then consumer will have more income to spend and if both products are normal then the demand for the both products will increase.

c)Diminishing marginal utility- The law of diminishing marginal utility states that the marginal utility derived from successive consumption of goods declines as the consumption increases due to which the indifference curves are convex in nature.