Directions:
- (3 points) Suppose you can separate consumers into two groups: Group 1 has a price elasticity of demand = -4 and group 2 has a price elasticity of demand of -6. If you could conduct third degree price discrimination, which group would you charge a higher price to? Why? Suppose the the profit maximizing price for group 2 is $36. What price should I charge group 1? Show all your work.
- (3 points) We have discussed how signals can be used to solve adverse selection problems. Provide a unique and personal example of adverse selection and discuss the possible signals that could be used to identify low and high quality types. Which signal would be most effective and why?
- (4 points) This question requires some extra research on your part. In class we have discussed extensively the notion of moral hazard. You may have heard of the economic problem of “free riding.” How can moral hazard be thought of as a type of free riding? Please explain fully and provide an example to illustrate your answer.
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