Microeconomics, 4e (Hubbard/O’Brien)
Chapter 16 Pricing Strategy
16.1 Pricing Strategy, the Law of One Price, and Arbitrage
1) Price discrimination
A) is the practice of charging different prices to different customers based on a seller’s personal
preferences and prejudices.
B) is the practice of charging different prices to different customers based on the different costs
of supplying the product to different customers.
C) is the practice of charging different prices to different customers when the price differences
cannot be attributed to variations in cost.
D) is the practice of giving preferential treatment to certain groups of customers based on their
long-standing relationship to the producer.
2) In the real world,
A) all sellers charge one price equal to the marginal cost of production.
B) profitable sellers will set one price based on the average elasticity of demand of buyers.
C) many firms charge different prices based on consumers’ willingness to pay.
D) all sellers charge one price set by the government.
3) Arbitrage
A) is the act of buying an item at a low price and reselling the item at a higher price.
B) is the act of selling an item on consignment and collecting a huge portion of the proceeds to
compensate for the seller’s time.
C) is the act of buying an item at a low price, bundling it with another and selling the new
package at a much higher price.
D) is any act of buying and selling that results in the seller earning an above normal profit.
4) Yield management is the practice of
A) determining production functions to minimize production costs.
B) forecasting competitors’ responses to price changes.
C) using buyer data to rapidly adjust prices.
D) using information technology to find the best interest rate.
5) The law of one price holds exactly only if
A) antitrust laws are being enforced.
B) buyers have complete information.
C) transactions costs are zero.
D) it is impossible for buyers to resell the good.
6) The expenses you encounter when you buy in one market and sell in a distant market are
known as
A) production costs.
B) fixed costs.
C) transactions costs.
D) sunk costs.
7) When you buy at a low price in one market then sell at a higher price in another market you
are engaging in
A) odd pricing.
B) arbitrage.
C) an antitrust prohibited practice.
D) price discrimination.
8) Buying at a low price in one market and reselling at a higher price in another market will
A) not generate any profit because of transportation costs.
B) not generate any profit because of transactions costs.
C) eventually eliminate all of the price differences.
D) eventually eliminate most, but not necessarily all, of the price differences.
9) Assuming zero transaction cost, if your local grocer buys oranges at a low price from an
orchard and resells them to you at a higher price, then the grocer’s revenue minus costs is known
as
A) arbitrage profits.
B) transactions profits.
C) pure profits.
D) excess profits.
10) The law of one price states
A) federal and state statutes that prohibit price discrimination.
B) that all customers should pay the same price.
C) that identical products should sell for the same price everywhere.
D) government regulation of prices for all firms.
11) A firm’s efforts to increase profit by price discrimination can be undermined by
A) arbitrage by buyers.
B) consumer ignorance.
C) differences in elasticity of demand.
D) seller market power.
12) According to a New York Times article, shoppers from New York City have played a game
of “retail arbitrage” by shopping at malls in Northern New Jersey, a state where there is no tax on
clothing and shoes. Even after accounting for transaction costs, shoppers could still save money
on their clothing and footwear purchases.
Source: Ken Belson and Nate Schweber, “Sales Tax Cut in City May Dim Allure of Stores Across
Hudson,” New York Times, January 18, 2007.
Is the term “arbitrage” correctly used here?
A) Yes, because shoppers were able to purchase items at lower prices even after deducting their
transaction costs.
B) No, “arbitrage” means buying at a low price and reselling at a higher price but no resale takes
place here.
C) Yes, arbitrage applies even if no resale takes place; in this case the profits are pocketed by the
customers themselves.
D) No, “arbitrage” does not apply to markets that are not in the same geographic area.
13) Lou buys an Iron Man 2 poster at a garage sale for $30 and resells it on eBay to Kyle for
$60. Which of the following statements is true?
A) The transaction has made Lou better off and Kyle worse off.
B) The transaction is economically inefficient.
C) The transaction has made Lou and Kyle better off.
D) It is not possible for Kyle to enjoy any consumer surplus from this transaction.
14) Lou buys an Iron Man 2 poster from Evan for $30 and resells it on eBay for $60. Which of
the following statements is false?
A) Lou has earned some arbitrage profits, assuming that transaction costs are negligible.
B) The transaction has made Evan worse off because he undersold the poster.
C) Lou has probably incurred some costs in connection with this sale.
D) It is possible that Evan has earned some producer surplus from this transaction.
15) For many products, such as fast foods, a variety of prices can be found, but sellers with
higher prices can expect to sell their products because
A) consumers are not sensitive to prices.
B) arbitrage will quickly eliminate price differences.
C) firms differentiate products in many ways, for example, higher priced fast food restaurants
may offer better service.
D) their demand is perfectly inelastic.
16) If firms differentiate their products in different ways and charge different price because of
these differentiation factors, then
A) the law of one price is not violated.
B) transaction costs are being ignored.
C) the firm must not be maximizing profit.
D) demand must be perfectly elastic.
Table 16-1
COMPANY
PRICE
Amazon.com
$20.05
BarnesandNoble.com
20.68
Walmart.com
25.97
Buy.com
24.48
Table 16-1 shows the price for the novel, Harry Potter and The Deathly Hallows at four online
bookstores.
17) Refer to Table 16-1. Which of the following can one conclude from the data above?
A) The data provides clear evidence of price discrimination in online bookstore market.
B) Amazon.com is able to charge a lower price for the item because it is more cost efficient than
the other three companies.
C) The item offered for sale is similar but not identical; the quality of service and delivery time
might vary from store to store, which justifies the price differences.
D) BarnesandNoble.com and Amazon.com have deliberately under-priced their product to force
the other two companies out of business.
18) The Athenian Theatre sells play tickets for the same play at different prices: a lower price to
those who opt for the seats at the back of the theatre and a higher price for those who purchase
seats in the front, around the stage. Which of the following statements is true?
A) This is an example of product differentiation but not price discrimination.
B) The theatre practices first-degree price discrimination by setting prices based on willingness
to pay.
C) Since the cost of producing the play does not change with the seating configuration, this is
evidence of price discrimination based on market segmentation.
D) Charging two different prices is an effective way to avoid an excess demand for play tickets;
the higher price lowers quantity demanded to some extent.
19) The act of buying a product at a low price in one market and reselling the product at a higher
price in another market is called arbitrage.
20) The law of one price states that identical products should sell for the same price everywhere
as long as transactions costs are zero.
21) In a perfectly competitive market, in the long run, arbitrage profits will be bid away.
22) Differentiating products to suit customers’ tastes is a form of price discrimination.
23) Are sellers who practice arbitrage taking advantage of buyers?
24) Under what circumstances will the law of one price hold, and when might it not hold?
25) The following table contains the actual prices charged by four Web sites for a DVD of the
movie Captain America: The First Avenger in November 2011.
Amazon
$16.99
Wal-Mart
19.96
CD Universe
22.19
DVD Empire
25.79
Explain whether the information in this table contradicts the law of one price.
16.2 Price Discrimination: Charging Different Prices for the Same Product
1) If a firm charges different consumers different prices for the same product and the difference
cannot be attributed to cost variations, then it is engaging in
A) odd pricing.
B) cost-plus pricing.
C) price discrimination.
D) markup pricing.
2) Why is price discrimination legal but not discrimination based on race or gender?
A) because price discrimination increases profits and therefore tax revenues for the government,
but discrimination based on race or gender reduces tax revenues
B) because price discrimination reduces deadweight loss, but discrimination based on race or
gender increases deadweight loss
C) because price discrimination involves charging people different prices based on their
willingness to pay rather than on the basis of arbitrary characteristics
D) because price discrimination enables firms to increase output and employment, but race or
gender based discrimination reduces employment
3) Firms price discriminate
A) to reduce the quantity sold so as to reduce production costs.
B) to increase profits.
C) to take advantage of customers.
D) to increase total economic surplus.
4) Toot Sweets Bakery sells freshly baked muffins from 6.30 am at $1.20 per muffins. By 4 pm,
the remaining muffins are marked down to $0.60 each. Which of the following statements is
true?
A) Toot Sweets engages in price discrimination; a higher price for those who cannot wait and a
lower price for those willing to wait until 4 pm.
B) Toot Sweets is trying to prevent the opportunity to make arbitrage profit.
C) Toot Sweets is trying to minimize its loss.
D) Toot Sweets has underestimated the demand for its muffins.
5) Which of the following is not a way by which price discriminating firms can segment a
market?
A) on the basis of time of purchase, for example long-distance calling
B) by requiring an advance purchase, for example air tickets
C) on basis of the buyer’s location, for example requiring out-of-state students to pay higher
tuition
D) on the basis of the supplier’s marginal cost of production, for example requiring customers to
pay a premium for customizing options
6) Which of the following products allows the seller to identify different groups of consumers
(segment the market) at virtually no cost?
A) early bird dinner specials
B) books sold online
C) a pair of Bose speakers
D) iPhones
7) Which of the following are necessary condition(s) for successful price discrimination?
a. zero transaction cost
b. a perfectly competitive market structure
c. an imperfectly competitive market structure
d. at least two different markets with different price elasticities of demand
e. at least two different markets with different price elasticities of supply
A) a, b, and d only
B) c and d only
C) a, c, d and, e only
D) a and c only
8) Most movie theatres charge different prices to different groups of customers for movie
admission but not on movie popcorn. Which of the following is a reason for this?
A) because the markup on movie popcorn is very high and movie theatres do not want to forego
this source of revenue
B) because the demand for popcorn is very high relative to the demand for movie admissions
C) because it is easier to limit resale in movie admissions but not in popcorn
D) because the cost of operating a concession stand in a movie theatre is very high compared to
the cost of showing a movie
9) Which of the following is a necessary condition for successful price discrimination?
A) The seller must possess market power.
B) The buyer must possess market power.
C) Transaction costs must be zero.
D) Buyers must have identical inelastic demands.
10) Successful price discrimination cannot take place if
A) the market is perfectly competitive.
B) the market can be segmented into different buyer groups.
C) customers are not able to resell the product.
D) the demand curve facing the firm is downward-sloping.
11) Consider the following actions undertaken by a firm:
a. charging the same price for products of different quality
b. charging different prices to different consumers for the same product when the variation
cannot be explained by cost differences
c. charging different prices for products of different qualities
d. charging a lower price to match a competitor’s price
Which of the above will be considered price discrimination?
A) a, b, c, and d
B) a, b, and d only
C) b and d only
D) a and b only
12) Price discrimination is possible in which of the following market structures?
a. perfect competition
b. monopoly
c. oligopoly
d. monopolistic competition
A) a, b, c, and d
B) c and d only
C) b and c only
D) b, c, and d only
13) Which of the following undermines a firm’s ability to engage in price discrimination?
A) the seller’s market power
B) the inability to prevent resale of the product from one market segment to another
C) buyers having different elasticities of demand for the product
D) the seller’s ability to segment the total market
14) Which of the following firms is not able to practice price discrimination?
A) movie theaters
B) commercial airlines
C) land-line telephone companies
D) the largest wheat farmer in Nebraska
Table 16-2
Quantity
Demanded in
Middle Fall
(tubes per week)
Price per
Tube
Quantity Demanded
in West Fall
(tubes per week)
Price per
Tube
1
$8
1
$5.00
2
7
2
4.50
3
6
3
4.00
4
5
4
3.50
5
4
5
3.00
Neem Products sells its Ayurvedic Neem toothpaste in two completely isolated markets with
demand schedules as shown in Table 16-2. The average cost of production is constant at $2 per
tube.
15) Refer to Table 16-2. How many tubes of toothpaste will Neem sell in Middle Fall and at
what price?
A) Q = 2 units; P = $7
B) Q = 3 units; P = $6
C) Q = 4 units; P = $5
D) Q = 5 units; P = $4
16) Refer to Table 16-2. How many tubes of toothpaste will Neem sell in West Fall and at what
price?
A) Q = 2 units; P = $4.50
B) Q = 3 units; P = $4
C) Q = 4 units; P = $3.50
D) Q = 5 units; P = $3
17) Refer to Table 16-2. What is the total revenue received from both markets combined?
A) $30
B) $34
C) $68
D) $70
18) Refer to Table 16-2. What are the total profits from both markets combined?
A) $50
B) $48
C) $18
D) $15
19) Refer to Table 16-2. Which of the following statements is true about the two markets?
A) The demand in Middle Fall is more price elastic than the demand in West Fall.
B) The demand in Middle Fall is less price elastic than the demand in West Fall.
C) The demand in Middle Fall is more income elastic than the demand in West Fall.
D) The demand in Middle Fall is more income elastic than the demand in West Fall.
20) A firm that can effectively price discriminate will charge a higher price to
A) customers who have the more elastic demand for the product.
B) customers who have the more inelastic demand for the product.
C) buyers who belong to the largest market segment.
D) buyers who are members of the smallest market segment.
21) For a firm that can effectively price discriminate, who will be charged a lower price?
A) customers who have an elastic demand for the product
B) customers who have an inelastic demand for the product
C) buyers that are members of the largest market segment
D) buyers that are members of the smallest market segment
22) Calling long distance is often more expensive on weekdays between 8 am and 5 pm than in
the evening hours. Why is this the case?
A) Telephone companies hope to discourage customers from calling long distance during the day
to keep their labor costs down.
B) The cost of making long-distance connections is higher during the day than in the evenings.
C) Businesses who must call suppliers or customers during business hours have few alternatives
and therefore have an inelastic demand during the workday compared to after-work hours.
D) Increasingly, businesses who must call suppliers or customers during business hours resort to
the internet, thereby reducing demand for long-distance calls. To make up for this fall in demand,
telephone companies charge higher rates.
23) The Bay Area subway system, BART, offers senior citizens discounted fares for BART
rides. This suggests that BART authorities believe that senior citizens have a ________ demand
for subway rides.
A) more income elastic
B) less income elastic
C) more price elastic
D) less price elastic
24) An article on how prices in South Bend, Indiana rise during Notre Dame home football
games noted: “For the Sept. 16 game against the University of Michigan, the South Bend
Marriott is charging $649 a night for a double room. …… The Marriott’s regular weekend price is
$149 a night.”
Source: Ilan Brat, “Notre Dame Football Introduces Its Fans To Inflationary Spiral, Wall Street
Journal, September 7, 2006, p. A1.
Which of the following statements is true?
A) The Marriott is practicing first-degree price discrimination by charging what the market will
bear.
B) This is evidence of third-degree price discrimination because hotel accommodation on a
particular day is not a product that can be resold later.
C) There is no evidence of price discrimination; the Marriott is responding to increased demand
for hotel rooms in the face of constant supply.
D) The Marriott has adopted this pricing strategy to capitalize on arbitrage profits.
25) From an economic perspective, price discrimination is desirable because
A) the increase in profits is more than offset by the loss in consumer surplus, resulting in a net
increase in economic surplus.
B) it enables firms to increase profits with no loss in economic surplus, and in turn, this could
provide firms with incentives to engage in beneficial product innovation.
C) the increase in profits results in higher corporate tax revenues received by the government
which could be used to subsidize consumption for low-income individuals.
D) it redistributes wealth from wealthy consumers to highly innovative firms.
26) Yield management and price discrimination have enabled firms to increase profits and, at the
same time,
A) reduce the cost of production.
B) capture some consumer surplus.
C) reduce transactions costs.
D) transfer some producer surplus to consumers.