361 Midterm Review #1 and #5.docx

Problem #1 Define ?profit maximizing rate discrimination? Rates are set generally to maximize profits but to discriminate in favor of those shipments with elastic demands (with respect for transfer rates) The general principle governing profit-maximizing price discrimination is to discriminate in favor of customers with more elastic demands and against those with less elastic demands Use this definition to explain why transfer rates are high (relative to cost) for the shipment of commodities of high value, and low (relative to cost) for things of low value. Rates are high relative to costs for the transfer of things of high value, and low relative to costs for things of low value Rationale: a seller?s profits are enhanced by discriminating against buyers with relatively inelastic demands and in favor of buyers with relatively elastic demands commodities of high-value ? transport costs will be a smaller part of the delivered price (inelastic demand) than when a low-value commodity is shipped the same distance (elasticity of demand will be greater); so commodities of high value will be discriminated against and charged higher rates Problem #5 Define the delivered price. What are its two components? Delivered price = production cost + transfer cost; includes all transfer costs; buyer pays all transfer charges Price = (1) price of the good or service + (2) transfer charges Price increases with distance If the drug store pays the transfer costs (delivers the hair spray for free), how is demand for hair spray affected? Demand will increase because the F.O.B. price will be smaller Two reasons why a lower F.O.B. price implies a larger quantity are: Because the individual demand curves are negatively inclined (when consumers are faced with lower prices, they buy more) The lower the F.O.B. price, the larger the market radius and hence the market area