ECON111 Lecture 8: WEEK 8 – The Firm and its Customers

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15 Mar 2020

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Week 8 the firm and its customers. Outline: introduction, production: key concepts, pricing and production decisions: profit maximisation, gains from trade, price elasticity of demand, introduction. In all developed countries, most people work for large firms. A firm"s success and ability to grow partly depends on its pricing and production decisions. Interactions between firms and workers determine wages, which are part of a firm"s production costs. (unit 6) Other key decisions for firms include choosing product prices and quantities to produce. Model of interactions between customers and profit maximising firms producing differentiated products. Factors that affect the firm"s choice of price and quantities produced (costs, price elasticity, market power) Profit and demand factors on the customers you have and how much they are willing to pay for what is being sold. This figure illustrates key decisions that a firm makes.

Related Questions

PLEASE ANSWER EACH QUESTION WITH A, B, C, and D. NOT ANSWERING ALL QUESTIONS OR INCORRECT ANSWERS WILL RESULT IN A THUMBS DOWN.

Question 1: Which of the following is not needed for price discrimination to be possible?

		A. The firm must have market power.
		B. The firm must be able to prevent resale and arbitrage.
		C. The firm must eventually learn about its customers' demands.
		D. The firm's customers must have different demand curves.

Question 2: Relative to standard monopoly pricing, first-degree price discrimination results in:

	A.	higher consumer surplus, higher producer surplus, and higher total surplus.
	B.	lower consumer surplus, higher producer surplus, and higher total surplus.
	C.	lower consumer surplus, higher producer surplus, and lower total surplus.
	D.	lower consumer surplus, lower producer surplus, and lower total surplus.

Question 3: Relative to perfect competition, first-degree price discrimination results in:

		A. higher consumer surplus, higher producer surplus, and higher total surplus.
		B. lower consumer surplus, higher producer surplus, and equal total surplus.
		C. lower consumer surplus, higher producer surplus, and equal total surplus.
		D. lower consumer surplus, lower producer surplus, and lower total surplus.

Question 4: If market demand is P = 100 - Q and the firm has a constant marginal cost of 20, then with first-degree price discrimination, the firm's producer surplus will be:

A.	$800.
B.	$1,600.
C.	$2,400.
D.	$3,200.

Question 5: For third-degree discrimination to be possible, which of the following features is not required?

		A. market power
		B. prevention of resale
		C. identification of each customer's demand before purchase
		D. customers with different demand curves

Question 6: A golf course has frequent players whose demand is Q_f = 260 - 0.4P and infrequent players whose demand is Q_i = 10 - 0.1P. The combined market demand is Q = 34 - 0.4P. The marginal cost and average total cost of providing a round of golf are $20. How much higher will the profit be if the golf course uses third-degree price discrimination instead of charging all golfers the same price?

A.	$0
B.	$7.50
C.	$10
D.	$110

Question 7: An airline sells seats on its flights to business travelers whose demand is Q_B = 300 - P and vacation travelers whose demand is Q_V = 150 - 0.5P. The combined market demand is Q = 450 - 1.5P. The marginal cost and average total cost of providing a seat on a flight are $200. How much higher will profit be if the airline uses third-degree price discrimination instead of charging all travelers the same price?

A.	$0
B.	$250
C.	$400
D.	$1,000

Question 8: If a firm practices third-degree price discrimination, the price charged should be higher in the market where demand is:

	A.	Higher.
	B.	Lower.
	C.	More price elastic.
	D.	Less price is elastic.

Question 9: The key difference between markets where third-degree price discrimination is possible and markets where second-degree price discrimination is possible is whether:

		A. resale is possible.
		B. customers have the same demand curves.
		C. firms have market power.
		D. firms can identify customers' demand before the customers make a purchase.

Question 10: For price discrimination via a quantity discount to work:

		A. customers who purchase larger quantities must have relatively elastic demand.
		B. customers who purchase larger quantities must have relatively inelastic demand.
		C. customers who pay a relatively high price must have relatively elastic demand.
		D. customers who pay a relatively low price must have relatively inelastic demand.

Question 11: A firm wants to offer a quantity discount to price-discriminate between buyers who are relatively uninterested in the product and buyers who are obsessively interested in it. The uninterested customers have a demand of Q_U = 30 - 0.5P. The package offered to them contains 10 units of the good at a price of $40 each. Which of the following packages designed for obsessed customers is incentive compatible?

	A.	60 units at a price of $10 each
	B.	40 units at a price of $10 each
	C.	60 units at a price of $20 each
	D.	40 units at a price of $20 each

Question 12: Which of the following conditions do not have to be met in order for indirect price discrimination by versioning to work?

		A.The firm's customers must have different demand curves.
		B. The marginal costs of producing each version of the product must be the same.
		C. The firm must be able to prevent resale.
		D. The firm must have market power.

	Willingness to pay (per month)
	Weight machines	Indoor pool
Abe	$60	$50
Betty	50	125
Chris	25	140

QUESTION 13
This table shows the willingness to pay off the only three potential customers of a firm that runs both a weight room and an indoor swimming pool. The weight room and pool each have a constant marginal cost of $20 per month. Which of the following pricing strategies yields the highest producer surplus?

		A. $60 for the weight room, $140 for the pool, or $175 for both
		B. $50 for the weight room, $125 for the pool, or $165 for both
		C. $25 for the weight room, $50 for the pool, or $70 for both
		D. $60 for the weight room, $130 for the pool, or $175 for both

Question 14: Which of the following features is needed to make bundling a possible price discrimination strategy but is not required for any other price discrimination strategies?

		A. Customers must have identical demand curves.
		B. The firm does not learn about customer demand until after purchase.
		C. Demand for two products must be negatively correlated.
		D. The firm must not have market power.

Question 15: Which of the following features is not needed for price discrimination using a two-part tariff to work?

		A. The firm must have market power.
		B. The firm must be able to prevent resale.
		C. The firm must learn about its customers' demands before purchases are made.
		D. The firm's customers must have different demand curves.

Question 16: A firm faces a market demand curve P = 50 - 5Q. It has a constant marginal cost of $10. Relative to standard monopoly pricing, how would a block pricing strategy where the first four units can be purchased for a price of $30 each, but two more units can be purchased for an additional $20 each change consumer surplus and producer surplus?

		A. Consumer surplus would decrease by $10, and producer surplus would increase by $20.
		B. Consumer surplus would increase by $10, and producer surplus would increase by $20.
		C. Consumer surplus would increase by $20, and producer surplus would increase by $10.
		D. Consumer surplus would increase by $20, and producer surplus would increase by $20.

Question 17: Relative to standard monopoly pricing, block pricing:

		A. decreases consumer surplus, increases producer surplus, and increases total surplus.
		B. increases consumer surplus, increases producer surplus, and increases total surplus.
		C. decreases consumer surplus, increases producer surplus, and decreases total surplus.
		D. decreases consumer surplus, decreases producer surplus, and decreases total surplus.

Question 18: Which of the following results in the highest amount of producer surplus?

	A.	bundling
	B.	third-degree price discrimination
	C.	block pricing
	D.	two-part tariffs

Question 19: Which of the following results in the highest amount of consumer surplus?

	A.	first-degree price discrimination
	B.	third-degree price discrimination
	C.	block pricing
	D.	two-part tariffs

Question 20: Which of the following results in the highest amount of total surplus?

	A.	third-degree price discrimination
	B.	block pricing
	C.	first-degree price discrimination
	D.	bundling

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Russian case study:

Russia has long been a preeminent global producer and supplier of gas, but the recent evolution of global market dynamics has begun to erode this status. Now, it finds itself at a crossroads that could determine its fate in this evolving market. Faced with the US shale gas revolution, competition from global LNG suppliers and new pipeline projects, an uncertain demand outlook in Russiaâs once captive European market, and slow penetration of high growth Asian markets, Russia may no longer be able to thrive at status quo and must take decisive steps to devise a strategy that addresses these challenges and ensures its continued role as a leading global gas producer and exporter. Russia undoubtedly has made some early progress on this front by making forays into liberalizing its gas export market, facilitating the rise of a handful of non-Gazprom producers, and pursuing options that begin to shift its strategic focus to Asian consumers. However, given Russiaâs heavy budget dependency on oil and gas revenues, coupled with the recent introduction of tax breaks to incentivize new high-cost resource development, the countryâs success in expanding gas production and capturing key export market share will depend first and foremost on sustained high oil prices to support government spending. The current system allows Russia to muddle through, but a more drastic price shock could have significant, detrimental knock-on effects for Russiaâs gas sector (five years ago the budget could balance at $50-55/bbl oil while breakeven prices were $117/bbl in 2012 and expected to remain at over $100 through the end of the decade).

Over time, Russia will have to introduce still more reforms from additional tax incentives to greater contract pricing flexibility and increased access for foreign investors if it hopes to remain a dominant global gas player. Russiaâs market position will become more difficult and uncertain post-2017 as competition rises from global LNG and unconventional producers. Russiaâs gas modernization efforts to date do not appear adequate to brace the industry for this uncertainty, and Russiaâs position increasingly will come under pressure absent more comprehensive reform of the domestic gas sector, additional tax incentives to expedite the development of key projects, and reconsideration of pricing mechanisms in contracts.

Arguably the greatest challenge to the Russian gas market in the future is the abundance of new gas suppliers and export options coming online over the next decade that will provide significant new volumes of gas at competitive prices, which could undermine Russiaâs current supplier relationships. At the center of this gas glut is the US shale revolution and the prospects for USLNG exports, which have had an immediate impact on Russiaâs market share and pricing. First, the abundance of new US shale-derived gas supplies has resulted in Russia losing the US market as a potential customer for exports from its Arctic LNG projects. In addition, Russia has been negatively impacted by flows of cheap LNG into the European market since 2008â2009, which has triggered a series of pricing renegotiations between Gazprom and its main European customers.

Russia has faced myriad challenges in its core European market: the reputational impact of its dispute with Ukraine, the Eurozone crisis causing a decline in gas demand, growing gas competition, and change in the EU regulatory framework. These changing dynamics have triggered an ongoing antitrust investigation on the grounds that Gazprom restricts European buyersâ rights to sell gas to one another and unfairly raises costs by linking prices to oil. The investigations have heightened tensions between Russia and the European Union.

EU policymakers are eager to diversify away from Russia, but the opportunity to do so is limited until Europe experiences far more rapid demand recovery. In the interim, poor economic performance, the availability of cheap coal, environmental regulations, and promotion of renewable technologies have taken their toll on European gas demand. While Gazprom has begun to experience some demand recovery in Europe and ongoing production challenges at Statoilâs Troll field in Norway have leant some near-term support to volumes of Russian gas exports to Europe, overall European demand remains weaker than in pre-crisis years, and the outlook is still uncertain.

In September 2012, the European Union launched an investigation into anti-competitive Gazprom practices. Russia, which feeds 26 percent of European gas consumption, did what it said it never would and, motivated by a combination of weaker demand and arbitration, rewrote long-term contracts to include a new price formula for certain European buyers. This move came at the expense of several billion dollars in budget revenue at a time when Russiaâs overall economic growth has slowed and the country has had to introduce considerable tax breaks to incentivize development of more difficult hydrocarbon plays.

Now, as Russia races against the clock to seize additional Asian market share and redirect volumes to these high-growth markets ahead of its competitors (namely LNG from incumbents like Australia and Qatar as well as new participants from North America and East Africa and pipeline gas suppliers like Turkmenistan, Uzbekistan, and Kazakhstan), its strategy is to employ both pipeline and LNG export options to tap into as much additional Asian market capacity as possible. But Russia faces a challenge on the implementation front. LNG projects have faced delays and even indefinite postponement in the case of Shtokman, and Russia has been unable to close on the Power of Siberia pipeline due to its challenges securing a pricing agreement with China. Other options include direct pipeline options to Japan and Korea, but these proposals also face political and security risks that could delay or prevent realization of these plans. Putin gradually has pivoted to Asia, both politically and economically, and Russia hopes to expand energy and trade ties not just with China, but also more broadly with Asia. However, the impact of changes in energy markets could subtly alter the relationship between Russia and China in ways that also could escalate tensions in the bilateral ties. While Russia sees China as a key partner in constraining US prerogatives, China sees Russia mostly as a source of energy and natural resource supply and a great power in decline.

Gas exports remain one of Russiaâs most effective political weapons. But the power Russia wields through its gas sector also comes at a tremendous cost. Gazpromâs relative stranglehold over the domestic and export market until relatively recently has hindered entry of foreign investors who could bring capital and technical expertise and limited sources of Russian budget revenue. On the export side, Russiaâs disregard for disruptions and the impact on customers further down the line in Western Europe has driven a wedge in the Russian-European gas relationship and compelled Europe to look into alternative supply sources from abroad as well as to its own un-conventionals potential to displace Russian supply over the next decade. Despite widespread bans on fracking in Europe, even the partial development of European shale resources or a growth in LNG imports could force further contract pricing revisions on Gazprom, underscoring the increasingly brittle state of Russiaâs traditional gas sector development model.

The Russian budget is nearly 50 percent dependent on oil and gas revenues, and while the dependence is far greater on the oil sector, the recent push by oil companies into more challenging plays, including tight oil and the Arctic, has required significant tax concessions from the government. By default, heavier burden has been transferred to the gas industry and expressed in the form of MET hikes to prevent a significant blow to budget revenues.

Case Study 1

What is the Russian political climate? How it is going to impact its LNG exports?(50 words)

How the government policies are hindering development of the LNG industries? ?(50 words)

If you were an investor would you invest in Russian LNG? ?(100 words)

ECON111 Lecture 8: WEEK 8 – The Firm and its Customers

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