Graphic Illustration

The MSU pricing problem and the concept of price discrimination can be illustrated graphically. Figure 12.2 shows demand curves for the general public in part (a) and for students in part (b). The aggregate demand curve in part (c) represents the horizontal sum of the quantities demanded at each price in the public and student markets. The associated marginal revenue curve, MRP+S, has a similar interpretation. For example, marginal revenue equals $25 at an attendance level of 20,000 in the public market and $25 at an attendance level of 40,000 in the student market. Accordingly, one point on the total marginal revenue curve represents output of 60,000 units and marginal revenue of $25. From a cost standpoint, it does not matter whether tickets are sold to the public or to students. The single marginal cost curve MC = $25 applies to each market.

Graphically solving this pricing problem is a two-part process. The profit-maximizing total output level must first be determined, and then this output must be allocated between sub-markets. Profit maximization occurs at the aggregate output level at which marginal revenue and marginal cost are equal. Figure 12.2(c) shows a profit-maximizing output of 60,000 tickets, where marginal cost and marginal revenue both equal $25. Proper allocation of total output between the two submarkets is determined graphically by drawing a horizontal line to indicate that $25 is the marginal cost in each market at the indicated aggregate output level. The intersection of this horizontal line with the marginal revenue curve in each submarket indicates the optimal distribution of sales and pricing structure. In this example, profits are maximized at an attendance (output) level of 60,000, selling 20,000 tickets to the public at a price of $125 and 40,000 tickets to students at a price of $75.

Price Discrimination for an Identical Product Sold in Two Markets

Price discrimination results in higher prices for market segments with low price elasticity (public) and lower prices for market segments with high price elasticity (students).

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