Mixed bag - Price discrimination, capital markets, interest rates, and risk. 1.
ID: 1206499 • Letter: M
Question
Mixed bag - Price discrimination, capital markets, interest rates, and risk. 1. I-Pass and Price Discrimination Up to a few years ago the toll on the Tri-State Toll Road in Illinois was 40 cents per booth (worked out to be 2 cents per mile as the toll booths were roughly 20 miles apart). To raise revenue the Toll Authority doubled the toll BUT also introduced the I-Pass, which allows one to pay the 40 cents if they rent, for a very minor fee, the I-Pass equipment for their car. Those without the l-Pass - such as travelers that rarely, if ever, use the toll - get dinged for 80 cents. This implies that two drivers using the same 20 mile stretch of toll road may pay different tolls - which is price discrimination in an economic sense. We argued in class that price discrimination may be successful if the elasticities of demand differ across consumer groups and that those with a relatively inelastic demand pay the higher price. Provide an explanation as to why a through-traveler, say a family driving from Columbus, Ohio to Milwaukee, Wisconsin for Thanksgiving might have a more inelastic demand for the Toll Road than someone that drives from Hammond to Oak Brook, Illinois every day for work (who probably has an I-Pass). 2. Real vs nominal returns - why inflationary expectations matter. Borrowers and lenders meet in capital markets to exchange loanable funds. Lenders expect to be compensated for all the bad things that may happen to their funds while they are out of their hands. Expecting that inflation may occur over the term of the loan, the borrower and lender must determine an appropriate inflation premium. Other things the same, why is it said that the borrower "wins" should inflation turn out to be higher than had been expected? Feel free to use a numeric example if that helps.Explanation / Answer
In this case, the drive through family has a more inelastic demand because he needs to use the highway to get from one part of the road to the other. And he will be ready to pay any price that is charged. However people who use that road to get to work everyday, may have other options/alternate routes available that makes their demand more elastic. Also due to the fact that these two markets (travellers in this case) are kept seperate, it is possible to charge one traveller a higher price( one who has more inelastic demand) than the one who has more elastic demand. When a lender lends money, he expects a return. Lets say that rate of return (assume it is 10%) is called the nominal rate of return. However if the price levels have increased by 5% (which is called inflation), the lender only effectively gets back 5% return (10%-5%).This rate is called the real rate of return Given this, the lender actually loses whenever the inflation rate is more than expected. Higher the inflation rate, lesser the real or effective rate of return for him.