Louisa owns the only pizza van in a small town. It costs her $50 to set up each day she decides to operate, and an additional $5 for each pizza she sells. The daily demand curve for pizzas is P = 35 – Q. Being an expert haggler, she is able to engage in first degree price discrimination (also known as perfect price discrimination).
Part A (1 mark) Briefly explain what first degree price discrimination is.
Part B (2 marks) What is Louisa’s profit, again assuming first degree price discrimination? What is the total consumer surplus?
Part C (1 mark) The locals know that Louisa engages in first degree price discrimination and are fed up with how much they have to pay for a pizza knowing that it only costs her $5 to make. They ask the council to implement a price ceiling equal to the marginal cost of making a pizza ($5). The council decides not to implement the suggested policy, saying that it would not actually help consumers. Can you think of why this might be the case?
Part D (2 marks) Instead, the council decides to adopt a policy where Louisa must charge all consumers the same price for their pizzas. What is Louisa’s profit in this case?
Part E (2 marks) Under the council’s policy from part D, Braedon sees the profits that Louisa is making and wants to open his own pizza van. However, Louisa wants to be the only pizza van in town, so threatens to drop her price to $5 if Braedon decides to open. As the only economic advisor in the town, Braedon comes to you for advice. The payoff matrix is shown below (Louisa’s payoff is the first entry, Braedon’s is the second).