Question

Suppose that the amusement park owner can practice perfect first-degree price discrimination by charging a different price for each ride. Assume that all rides have zero marginal cost and all consumers have the same tastes. Will the monopolist do better charging for rides and setting a zero price for admission, or better by charging for admission and setting a zero price for rides?

Short answer

Charging for admission with a zero price for rides might be practically preferable, but in theory, both methods yield equal profit.

Step-by-step solution

Understand Price Discrimination

First-degree price discrimination means charging each consumer the maximum price they are willing to pay for each ride. This allows the monopolist to capture the entire area under the demand curve, extracting all consumer surplus as profit.

Analyze Charging for Individual Rides

With zero marginal cost, charging for each ride using perfect first-degree price discrimination means the monopolist collects the consumer's entire willingness to pay for each ride. This theoretically allows capturing maximum possible earnings from each consumer.

Examine Charging for Admission

Alternatively, the monopolist can charge an entrance fee that extracts the total consumer surplus for the entire visit, while setting the price per ride to zero. The price of admission would be set equal to the total value consumers place on all rides.

Compare Outcomes

When charging for admission, the park captures the total willingness to pay for all possible rides upfront. While when charging per ride, the owner must assess and capture the maximum willingness to pay for each separate ride. Both strategies should, in theory, allow the monopolist to collect the same total consumer surplus if consumers have identical tastes.

Conclusion

In a perfect scenario where the monopolist can perfectly price discriminate, both methods should yield equal profit because the total consumer surplus captured is the same in both scenarios. However, practically, charging for admission with free rides may reduce transaction costs and simplify operations.

Key concepts

First-degree Price Discrimination

First-degree price discrimination, also known as perfect price discrimination, is a pricing strategy where a seller charges each consumer the maximum amount they are willing to pay. This is achieved by setting personalized prices for every single customer or, in this context, for each ride in an amusement park. The essence of first-degree price discrimination lies in the seller's capacity to extract the full consumer surplus — which is the difference between what consumers are willing to pay and what they actually pay.

• This method requires detailed knowledge about each consumer's willingness to pay.
• It allows the monopolist to maximize profits by capturing the entire area under the demand curve.
• By setting different prices for different consumers, the seller transforms consumer surplus into additional profit.

While theoretically ideal for profit maximization, practical implementation can be challenging, as it requires significant information about consumers' preferences and behaviors.

Consumer Surplus

Consumer surplus refers to the benefit or gain consumers receive when they pay a price that is lower than the maximum they're willing to pay. It's the difference between the highest price a consumer is willing to pay for a good or service and the actual market price they pay. In a perfectly competitive market, consumer surplus is an indication of the efficiency of the market.
In the scenario of first-degree price discrimination, the goal of the monopolist is to minimize or eliminate consumer surplus by charging prices that reflect each consumer's maximum willingness to pay. This way:

• The monopolist captures all the value consumers derive from the product or service as profit.
• All consumer surplus is transformed into increased revenue for the seller.

While it's ideal for the seller, it leaves consumers with no additional surplus, reducing consumer welfare but maximizing seller profit.

Monopoly Pricing

Monopoly pricing occurs when a single seller dominates the market. With no competitors, the monopolist has the power to set prices at their discretion, often above marginal costs, to maximize profits. In our amusement park scenario, the owner acts as a monopolist when setting prices for admission and rides.

• A monopolist often targets capturing consumer surplus through strategic pricing methods.
• Unlike in competitive markets, monopoly pricing results in higher prices and typically lower consumer surplus.

The ability to implement perfect first-degree price discrimination enhances the monopolist's ability to tailor prices, thus further optimizing profits by harnessing the full consumer surplus. It highlights the unique dynamic where monopolists can choose pricing tactics that would otherwise not be feasible in more competitive markets.

Marginal Cost

Marginal cost is the additional cost incurred for producing one more unit of a good or service. In ideal situations, particularly in the context of price discrimination within monopolies, the marginal cost is a crucial factor.
In the case of the amusement park charging for rides, if the marginal cost is zero — meaning it costs nothing extra to offer one more ride:

• The profit from each additional ride is solely dependent on the price set, since no additional cost is incurred for providing that ride.
• Zero marginal cost allows the park owner to focus entirely on capturing consumer surplus without concern for production costs.

Zero marginal cost simplifies the calculus for the monopolist, as every dollar collected from consumers directly contributes to profit, emphasizing the potential for maximized earnings through strategic pricing.