An incumbent's threat to use limit pricing if a firm enters the market
A)is credible if the firms have identical costs and market demand supports both firms.
B)is credible if the firms have different costs and market demand won't support both firms.
C)is not credible if the firms have different costs and market demand won't support both firms.
D)is cheap talk, because the other firm will enter, and the incumbent will still be able to charge monopoly pricing.

Question

Quizplus · Accepted Answer

The incumbent's threat to use limit pricing is credible if the firms have different costs and market demand won't support both firms. In this scenario, the incumbent has lower costs and can sustain lower prices for a longer period compared to the entrant. Therefore, the incumbent can effectively deter the entrant by using limit pricing, which involves setting low prices to make it unprofitable for the entrant to enter the market. If market demand would support both firms, the incumbent may not be able to sustain limit pricing as the entrant could still profitably stay in the market. If the firms have identical costs, the incumbent would not have an advantage in the market and would not be able to use limit pricing to deter the entrant effectively. The answer C is incorrect because the difference in costs is a key condition for limit pricing to be credible. The answer D is incorrect because limit pricing can be an effective way for the incumbent to deter entry, especially if the entrant is risk-averse and does not want to incur losses in the short run.

An Incumbent's Threat to Use Limit Pricing If a Firm