## Questions

1. This chapter has presented some evidence that consumers

derive utility from getting a good deal. Have

you observed evidence that people purchase goods

when it is not necessarily in their best interest just so

they can get a good deal?

2. If retailers and manufacturers are aware that consumers

derive utility from “getting a good deal,” they may be

able to take advantage of this to increase their own

profits. Can you find evidence that retailers take steps

to manipulate the perception of the deals they offer?

3. Policy makers concerned with the increasing number of

overweight consumers have long complained about the

pricing of sodas at fast food restaurants. In most cases, a

small soda (usually around 16 ounces) sells for a couple

dollars. For just a few cents more, one could purchase

a drink that was double that size and obtain a much

better deal. Why would fast food chains offer such steep

discounts on larger sodas? In one extreme case, a major

fast food chain has offered all sizes of drinks for the

same price. How could this be profitable? Policymakers

have suggested requiring linear pricing (eliminating

discounts for larger amounts) to fight obesity. New York

also attempted to ban the sale of large soft drinks. Are

these policies likely to be effective?

4. Suppose a telephone company had two kinds of customers.

One had a utility function that could be represented

as u1 x =5x −x2 −k x , where x is the total

amount of time spent on the phone and k is the total cost

to the customer for service. This results in a marginal

utility curve u1 x x= 5− 2x− k x. The other

type of consumer possesses a utility function that

can be written as u2 x =5x −x2 −k x −x k x ,

resulting in a marginal utility curve u2 x x =

5 −2x − k x− k x −x k x

x

k x 2 . Suppose that each faces

no budget constraint (so that they will purchase until

marginal utility declines to zero). Suppose the firm

charges a linear price so that k x = px, and marginal

cost is given by k x x= p. What is the demand

curve for each customer type? (Hint: Simply solve each

case for the amount of line use, x, that results in zero

marginal utility). Are these demand curves downward

sloping? Alternatively, suppose that the firm charges a

flat fee, so that k x =p, and k x x =0. What is the

demand curve for each consumer type given this pricing

structure? Are these demand curves downward sloping?

Which consumer displays a desire for transaction utility?

How does this influence demand under each pricing

scheme? What does demand look like if consumers face

a two-part tariff so that k x = p0 + p1x, so that

k x x =p1? (Do not solve for the demand curve, but

give some intuition as to how it will behave.)

5. Further, suppose that the cost function for providing

minutes on the phone is given by c x = x2. The profit

function is given by π =k x* −C x* , where x* is the

optimal consumption given the pricing scheme solved

in the previous exercise. What are the optimal price

choices for the firm under linear or flat-fee pricing if all

customers were of type 1? Write down the profit

function for each pricing scheme. Use a spreadsheet

application (like Microsoft Excel) to solve for the price

that maximizes the profit by trying various prices until

you find the price yielding the highest profits. Which

pricing scheme provides greater profits? Now try the

same exercise assuming all customers are of type 2.

Which pricing scheme now provides the greatest

profits? How do you think the answer would change if

the phone company believed they would have customers

of both types?