A single firm that charges the monopoly price in the market earns $800.If another firm successfully enters the market,the incumbent's profits fall to $500 and the entrant earns $450.If the incumbent engages in limit pricing,its profits are $600.For what interest rate,i,is limit pricing a profitable strategy for the incumbent? A) i

Question

A single firm that charges the monopoly price in the market earns $800.If another firm successfully enters the market,the incumbent's profits fall to $500 and the entrant earns $450.If the incumbent engages in limit pricing,its profits are $600.For what interest rate,i,is limit pricing a profitable strategy for the incumbent?
A) i < 0.5
B) 0.5 < i < 1.0
C) 1.0 < i < 1.5
D) i > 1.5

Quizplus · Accepted Answer

If the incumbent continues to charge the monopoly price, its profits will be $800. 
If the entrant successfully enters the market, the incumbent's profits fall to $500 and the entrant earns $450. Together, they earn $950. 
If the incumbent engages in limit pricing, its profits are $600, while the entrant earns $0.

Therefore, the incumbent's decision is between earning $600 (limit pricing) or $500 (if the entrant successfully enters the market). 
The incumbent's profit if it continues to charge the monopoly price is irrelevant since the question asks about the profitability of limit pricing.

We can set up an equation to solve for the critical interest rate:

$600 = $500/(1+i) + $450(1/(1+i))
Solving for i, we get i = 0.5, which is less than the interest rate on investment.

Therefore, limit pricing is a profitable strategy for the incumbent at an interest rate less than 0.5. The answer is A.

A Single Firm That Charges the Monopoly Price in the Market