A monopolist produces a good at zero marginal cost. It knows that two equal sized subgroups exist in the market for its produce, but cannot differentiate between them by sight. Group I value quality of service highly. The price they are willing to pay for any quality level, Q, is given by PI = 5 – Q Group II are less willing to pay for quality of service, with PII = 3 – 2Q.
The monopolist wishes to practice price discrimination, by offering two price and quality bundles, in the hope that each group will choose the bundle set for it. One economist suggests that the two choices should be: Bundle 1. Quality level Q=5 at a cost to the consumer of 12.5 and Bundle 2. Quality level Q = 1.5 at a cost to the consumer of 2.25
(i) Why may these have been suggested and why would they not be optimal?
(ii) Devise the optimal strategy for the monopolist and determine his profit level under your suggested strategy.
(iii) How much consumer surplus does each type of customer gain?