A monopolist earns $50 million annually and will maintain that level of profit indefinitely,provided no other firm enters the market.If another firm successfully enters the market,the incumbent's profits remain at $50 million the first period,but fall to $25 million annually thereafter.The opportunity cost of funds is 10 percent,and profits in each period are realized at the beginning of each period.If the monopolist can earn $27 million indefinitely by limit pricing,should it do so?
A) Yes, it will earn $297 million in present value if it does this.
B) Yes, it will earn $270 million in present value if it does this.
C) No, it will earn $297 million in present value if it does this.
D) No, it will earn $270 million in present value if it does this.

Question

Quizplus · Accepted Answer

If the monopolist maintains its current level of profit, it will earn $50 million annually, with a present value of $500 million (assuming a discount rate of 10%). However, if another firm enters the market, its profits will fall to $25 million annually, with a present value of $250 million.

If the monopolist chooses to limit pricing, it will earn $27 million annually indefinitely, with a present value of $270 million. This is a better option than risking a new entrant and potentially losing half of its profits.

Therefore, the best choice is for the monopolist to limit pricing, earning a present value of $297 million ($500 million for five years at $50 million annually, plus $270 million for all subsequent years at $27 million annually).

A Monopolist Earns $50 Million Annually and Will Maintain That