Nespresso produces small coffee machines that consumers can buy to quickly and easily make coffee in

their own home. To make coffee a user inserts a pre-made capsule into the machine, and the machine

uses the contents of that capsule to produce a cup of coffee within a minute. Each machine lasts for

many years, but each capsule can only produce one cup of coffee.

Suppose that Nespresso can set a price both for the machine and for the individual coffee capsules.

Nespresso's MC of machine production is N100. Their MC of capsule production is N1.

There are two types of coffee drinkers who are considering buying a Nespresso machine, low-use customers

(who have an average annual demand curve of Q = 200 25P) and high-use customers (who

have an average annual demand curve of Q = 500 20P). In both of these demand curves, Q is in

average cups of coffee per year, and P is the price per capsule. (It's okay if Q isn't an integer, since it's

an average.) Suppose there are 100 customers of each type.

(a) Suppose that Nespresso decided to charge N1 for each coffee capsule.

i. Assuming they're still willing to buy the machine, what quantity of coffee capsules would

each type of customer buy?

ii. Given this, what is the highest price that Nespresso could charge for the machine and still

have both types of consumers purchase it? (Hint: think about consumer surplus!)

iii. Therefore, with this pricing scheme, how much profit does Nespresso make from each low-type

customer? How much from each high-type customer? What are their overall profits?

(b) Rather than charging a high price for the machine and a low price for each capsule, let's try the

opposite. In particular, suppose that Nespresso charged only N100 (their marginal cost) for each

machine, but charged N4.50 for each capsule.

i. Under this pricing scheme, assuming they're willing to buy the machine, how many coffee

capsules will each type of customer use each year?

ii. Given that answer, are both types of consumers willing to buy the machine at the price of

N100? (Hint: think about consumer surplus!)

iii. Therefore, with this pricing scheme, how much profit does Nespresso make from each low-type

customer? How much from each high-type customer? What are their overall profits?

(c) Comment (briefly) on which of the two pricing schemes ((a) or (b)) is more profitable overall and

why. Is it also more profitable for each customer type individually?