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?