Question

A cable TV company offers, in addition to its basic service, two products: a Sports Channel (Product 1) and a Movie Channel (Product 2). Subscribers to the basic service can subscribe to these additional services individually at the monthly prices P1 and P2, respectively, or they can buy the two as a bundle for the price PB, where PB 6 P1 + P2. They can also forgo the additional services and simply buy the basic service. The company’s marginal cost for these additional services is zero. Through market research, the cable company has estimated the reservation prices for these two services for a representative group of consumers in the company’s service area. These reservation prices are plotted (as x’s) in Figure 11.21, as are the prices P1, P2, and PB that the cable company is currently charging. The graph is divided into regions I, II, III, and IV.

a. Which products, if any, will be purchased by the consumers in region I? In region II? In region III? In region IV? Explain briefly.

b. Note that as drawn in the figure, the reservation prices for the Sports Channel and the Movie Channel are negatively correlated. Why would you, or why would you not, expect consumers’ reservation prices for cable TV channels to be negatively correlated?

c. The company’s vice president has said: “Because the marginal cost of providing an additional channel is zero, mixed bundling offers no advantage over pure bundling. Our profits would be just as high if we offered the Sports Channel and the

Movie Channel together as a bundle, and only as a bundle.” Do you agree or disagree? Explain why.

d. Suppose the cable company continues to use mixed bundling to sell these two services. Based on the distribution of reservation prices shown in Figure 11.21, do you think the cable company should alter any of the prices that it is now charging? If so, how?

Short answer

1. The consumers of region I will not buy any of the products because the reservation price for the goods will be lower than the optimal prices set by the cable company. The consumers of region II will buy Movie Channel only they are have a greater reservation price (equal to or higher than the optimal price) for it but very lower price (less than the optimal price) for Sports Channel. The consumers of region III will buy Sports Channel only because they have a greater reservation price (equal to or higher than the optimal price) for it but very lower price (less than the optimal price) for Movie Channel. The consumers of region IV will buy both the goods as a bundle because they are offering a similar price for both the goods.

2. The consumer’s reservation prices for cable TV channels are negatively correlated because a person cannot enjoy both the channels at a time.

3. Agree with the statement. Charging separate pricing for channels from some consumers will not provide any additional profit level to the company because the marginal cost of providing one more channel is zero.

4. The company should charge pure bundle price from consumers instead of mixed bundle prices.

Step-by-step solution

Step 1. Deciding the type of consumers for both the goods.

The figure depicts the reservation price of different customers for both the goods. Good 1 is placed on x-axis and good 2 is placed on Y-axis.

Region Idepicts those consumers whose reservation prices for Good 1 and Good 2 is less than the optimal price or bundle price set by the producer for both the goods. These consumers will not be able to buy any of the products (Movie channels or Sports channel). They want to enjoy the basic services of the cable.

Region IIdepicts those consumers whose reservation price for Good 1 is very large compared to Good 2. Their reservation price for Good 1 is equal to or above the optimal price set by the producer. But their reservation price for Good 2 is very low compared to the optimal for it. It shows ynthey are more interested in Sports Channel compared to Movie Channel.

Region IIIdepicts those consumers whose reservation price for Good 2 is very large compared to Good 1. Their reservation price for Good 2 is equal to or above the optimal price set by the producer. But their reservation price for Good 1 is very low compared to the optimal for it. It shows they are more interested in Movie Channel compared to Sports Channel.

Region IV depicts those consumers whose gap between the reservation prices for both the goods is less compared to the consumers of region I and region II. It shows that they are ready to pay same level of reservation prices for both the channels unlike consumers of region II and III that are ready to pay more for one good and less for other.

Step 2. Argument for option ‘b’.

Suppose a person wants to enjoy both TV channels (Sports and Movie). He is ready to pay equal amount of reservation prices for it. In the leisure time, if he wishes to enjoy both the channels at a time, it is impossible for him to do so. It concludes that a person can watch a single channel at a time. And he will spent more time on watching those channel which he prefers most and other will give less time to other channels.

That’s why he will offer more money for his favorite channels and less for others.This is the reason why reservation prices for Good 1 (Movie Channels) and Good 2 (Sports Channels) are negatively correlated.

Step 3. Argument in favor of statement in ‘c’.

One would agree with the statement of company’s vice president. The marginal cost of providing additional channel is zero. It means that the ‘separate pricing policy’ is not providing any extra profit to the company. If the company decides to sell both the channels under pure bundling strategy, their profit won’t reduce.

Hence the company should follow pure bundling pricing strategy as mixed bundling is not proving any extra benefit to the company’s profit.

Step 4. Argument for option ‘d’.

The figure shows that most of the consumers (including Consumers of region II and region III) lie on the right side of the diagonal line (bundle price). If the TV Company applies pure bundling pricing strategy for channels, it will receive more revenue. Since marginal cost for adding more channels is zero for the company, there profit would be equal to the amount received as revenue.

If Company switches from mixed bundling to pure bundling pricing strategy for channels, it might be possible that the profit of the Company will increase.