Consider an incumbent successfully links the preentry price and postentry profit to prevent entry.The incumbent's monopoly profit is $10 million.If a rival successfully enters the market, the incumbent's profits will fall to $4 million.If the incumbent lowers output to 25,000 units, its rival will stay out of the market resulting in an infinite stream of profits of $8 annually.Due to a recent loan default, the current interest rate is whopping 210 percent.Is limit pricing profitable for the incumbent?
A)Yes, since $19.05 million is greater than $2 million.
B)No, since $1.91 million is less than $2 million.
C)No since $4 million is less than $4.2 million.
D)Linking the preentry price to the postentry profit is sufficient to guarantee the profitability of limit pricing.

Question

Quizplus · Accepted Answer

The present value of the infinite stream of profits at an interest rate of 210% is $1.91 million, which is less than the $2 million loss from the rival entering the market. Thus, limit pricing is not profitable.

Consider an Incumbent Successfully Links the Preentry Price and Postentry