Question 1

Limit pricing is:
A) a strategy whereby a firm temporarily prices below its marginal costs to drive competitors out of the market.
B) a strategy used by a vertically integrated firm to raise rivals' costs of inputs, while holding constant final product prices.
C) a strategy whereby an incumbent maintains a price below the monopoly price in order to prevent entry.
D) the act of charging a low price initially upon entering a market to gain market share.

Accepted Answer

Limit pricing is a pricing strategy in which an incumbent firm maintains a price below the monopoly price in order to prevent entry. By keeping the price low, the incumbent firm makes it unprofitable for potential new entrants to enter the market. This strategy allows the incumbent firm to maintain its market power and enjoy monopoly profits in the long run.

Question 2

Under limit pricing,the incumbent will produce:
A) more than the monopoly output and charge a price that is greater than the monopoly price.
B) less than the monopoly output and charge a price that is greater than the monopoly price.
C) more than the monopoly output and charge a price that is less than the monopoly price.
D) less than the monopoly output and charge a price that is less than the monopoly price.

Accepted Answer

Under limit pricing, the incumbent firm produces more than the monopoly output to saturate the market and sets a price lower than the monopoly price to deter entry by potential competitors. This strategy makes it unattractive for new firms to enter the market because they would have to accept lower profits or incur losses.

Question 3

Which of the following is a correct statement?
A) Predatory pricing is easy to prove in a court of law.
B) An incumbent firm may experience a learning curve that allows it to produce at a lower cost than a potential entrant.
C) A firm receives no individual benefit from strategies that raise the marginal costs of its rivals.
D) No individual firm can benefit from strategies that raise the fixed costs of all the firms in the industry.

Accepted Answer

This statement is true based on the concept of the learning curve, which suggests that as a firm produces more output, it becomes more efficient and can lower its costs. This can be a barrier to entry for potential entrants who do not have the experience or knowledge to produce at a lower cost.

A) This statement is false because predatory pricing is difficult to prove as it requires showing that a firm is intentionally pricing below cost to drive out competitors. 
C) This statement is false because a firm can benefit from strategies that raise its rivals' marginal costs, as it may lead to higher prices and increased market share for the firm. 
D) This statement is false because a firm can benefit from raising fixed costs if it can afford them and they create barriers to entry for potential competitors.

Question 4

Consider an incumbent that successfully links the pre-entry price and post-entry 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 million 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 $1.905 million is less than $2 million.
C) No since $4 million is less than $4.2 million.
D) Linking the pre-entry price to the post-entry profit is sufficient to guarantee the profitability of limit pricing.

Accepted Answer

Limit pricing is not profitable for the incumbent because the present value of the infinite stream of profits at the high interest rate is less than the profit from a single year without entry. At a 210% interest rate, the present value of $8 million annually is calculated using the formula PV = P / i, where P is the annual profit and i is the interest rate. Thus, PV = $8 million / 2.1 = $3.81 million. Since the incumbent's monopoly profit without entry is $10 million, even a single year's profit without entry is significantly higher than the present value of the reduced profits under limit pricing.

Question 5

A two-way network linking nine users creates how many potential network connections?
A) 72
B) 56
C) 90
D) 18

Accepted Answer

The number of potential connections in a two-way network linking n users is given by the formula n(n-1). For 9 users, this is 9(9-1) = 9*8 = 72.

Question 6

Firms that can effectively price discriminate can increase profitability when they engage in:
A) limit pricing.
B) vertical foreclosure.
C) a price-cost squeeze.
D) Any of the statements associated with this question are correct.

Accepted Answer

Firms that can effectively price discriminate can increase profitability in several ways, including through limit pricing, vertical foreclosure, or a price-cost squeeze. Therefore, any of the statements associated with this question are correct.

Question 7

A single firm that charges the monopoly price in the market earns $600.If another firm successfully enters the market,the incumbent's profits fall to $350 and the entrant earns $275.If the incumbent engages in limit pricing,its profits are $400.For what interest rate,i,is limit pricing a profitable strategy for the incumbent?
A) i > 4
B) i < 0.25
C) 0.75 < i < 4
D) 0.25 < i < 0.75

Accepted Answer

The answer of A single firm that charges the monopoly...

Question 8

An example of vertical foreclosure is when a firm:
A) temporarily prices below its marginal cost to close competitors out of the market.
B) merges with a rival firm with the intention of eliminating the rival firm's product from the market.
C) that controls an essential upstream input refuses to sell to other downstream firms that need the input.
D) merges with a rival firm with the intention of eliminating the rival firm's product from the market and that controls an essential upstream input refuses to sell to other downstream firms that need the input.

Accepted Answer

Vertical foreclosure occurs when a firm controls an essential upstream input and uses this control to exclude or discriminate against downstream rivals. The scenario described in option C – a firm that controls an essential upstream input refusing to sell to other downstream firms – is the best example of vertical foreclosure. The other options describe anticompetitive behavior, but not necessarily vertical foreclosure.

Question 9

Suppose the inverse market demand is given by P = 20 − Q.If the incumbent continues to produce eight units of output,which of the following equations best summarizes the potential entrant's residual demand curve?
A) P = 12 − Q
B) P = 8 − Q
C) P = 20 − 12Q
D) P = 12 − 8Q

Accepted Answer

The incumbent produces 8 units, so the total quantity Q in the market demand equation P = 20 - Q becomes Q + 8 when considering the entrant's production. Therefore, for the entrant, the price P they face is based on their quantity Q plus the incumbent's 8 units. Substituting Q + 8 for Q in the original demand equation gives P = 20 - (Q + 8), which simplifies to P = 12 - Q. This represents the residual demand curve the entrant faces, taking into account the incumbent's production.

Question 10

Firms 1 and 2 compete in a Cournot duopoly.If firm 1 adopts a strategy that raises firm 2's marginal cost:
A) firm 2 will increase its output.
B) firm 1 will lose market share.
C) firm 1 will enjoy higher profits.
D) All of the statements associated with this question are correct.

Accepted Answer

If firm 1 raises firm 2's marginal cost, firm 2 will decrease its output, allowing firm 1 to increase its market share and charge higher prices, leading to higher profits. Therefore, only option C is correct.

Question 11

Which of the following is NOT an example of a network?
A) Airlines
B) Trucking
C) Telecommunications
D) None of the statements are correct.

Accepted Answer

All options given are examples of networks, so none of the statements are incorrect. Therefore, option D is the correct answer.

Question 12

Consider an incumbent that is a monopoly currently earning $1 million annually.Given the declining costs of raw materials,the incumbent believes a new firm may enter the market.If successful,a new entrant would reduce the incumbent's profits to $750,000 annually.To keep potential entrants out of the market,the incumbent lowers its price to the point where it is earning $850,000 annually for the indefinite future.If the interest rate is 5 percent,does it make sense for the incumbent to limit price to prevent entry?
A) No, since $2 million > $250,000.
B) Yes, since $2 million > $250,000.
C) No, since $5 million > $100,000.
D) Yes, since $250,000 > $5 million.

Accepted Answer

To determine if it makes sense for the incumbent to limit price to prevent entry, we need to compare the present value of profits in the two scenarios: with entry and without entry.

If the incumbent does not limit price and a new entrant successfully enters, the incumbent's profits would decrease from $1 million to $750,000 annually. Using a discount rate of 5%, the present value of these profits is:

PV = ($750,000/0.05) = $15 million

If the incumbent limits price and keeps the new entrant out, they will earn $850,000 annually indefinitely. The present value of these profits is:

PV = ($850,000/0.05) = $17 million

Therefore, it makes sense for the incumbent to limit price to prevent entry as the present value of profits is higher compared to the scenario with entry. The correct answer is B.

Question 13

A network linking eight users is typically:
A) less likely to exhibit bottlenecks than a network linking two users.
B) more than four times as valuable as a network linking two users.
C) four times as valuable as a network linking two users.
D) less than four times as valuable as a network linking two users.

Accepted Answer

According to Metcalfe's Law, the value of a telecommunications network is proportional to the square of the number of connected users of the system (n^2). Therefore, a network linking eight users (8^2 = 64) is more than four times as valuable as a network linking two users (2^2 = 4), since 64 is more than 4 times 4.

Question 14

Penetration pricing is a way to:
A) raise a rival's marginal cost.
B) lower a rival's input costs.
C) increase a rival's fixed costs.
D) gain a critical mass of customers.

Accepted Answer

Penetration pricing is a strategy where a company sets a low price for its products or services initially in order to attract a large number of customers and gain a foothold in the market. The goal is to create a critical mass of customers who will then spread the word about the product or service, leading to more sales over time. This strategy can help the company establish itself in the market and build a customer base quickly. Therefore, gaining a critical mass of customers is the best choice among the options given.

Question 15

Smyth Industries operated as a monopolist for the past several years,earning annual profits amounting to $50 million,which it could have maintained if Jones Incorporated did not enter the market.The result of this increased competition is lower prices and lower profits; Smyth Industries now earns $10 million annually.The managers of Smyth Industries are trying to devise a plan to drive Jones Incorporated out of the market so Smyth can regain its monopoly position (and profit).One of Smyth's managers suggests pricing its product 50 percent below marginal cost for exactly one year.The estimated impact of such a move is a loss of $1 billion.Ignoring antitrust concerns,compute the present value of Smyth Industries' profits,if it could have remained a monopoly when the interest rate was 5 percent.
A) $100 million
B) $200 million
C) $210 million
D) $1.05 billion

Accepted Answer

The present value of Smyth Industries' profits as a monopoly, ignoring the $1 billion loss from the pricing strategy and antitrust concerns, is calculated using the formula for the present value of a perpetuity: PV = P / r, where P is the annual profit ($50 million) and r is the interest rate (5% or 0.05). Thus, PV = $50 million / 0.05 = $1 billion. However, since the question asks for the present value "if it could have remained a monopoly," we do not subtract the $1 billion loss from the pricing strategy, leading to a present value of $1 billion, which is not explicitly listed but closest to option D, $1.05 billion, due to rounding or a possible misunderstanding in the question's phrasing.

Question 16

The price-cost squeeze is:
A) a tactic used by a vertically integrated firm to raise rivals' costs of inputs, while maintaining final product prices.
B) a strategy whereby a firm temporarily prices below its marginal costs to drive competitors out of the market.
C) a strategy whereby an incumbent maintains a price below the monopoly price in order to prevent entry.
D) the act of charging a low price initially upon entering a market to gain market share.

Accepted Answer

A price-cost squeeze involves a vertically integrated firm manipulating the costs of inputs for competitors while keeping the final product prices stable, making it harder for rivals to compete.

Question 17

Which of the following is an INCORRECT statement about predatory pricing?
A) It benefits the firm engaging in predatory pricing to have deeper pockets than its prey.
B) Reputation for taking tough actions to drive a competitor out of the market can enhance the benefits received from the firm engaging in the predatory pricing.
C) Having its prey stockpile its product produces more benefits to the firm engaging in the predatory pricing.
D) None of the statements are correct.

Accepted Answer

Stockpiling its product by the prey would not benefit the firm engaging in predatory pricing. In fact, it would result in increased inventory costs for the prey and may cause it to exit the market sooner. Therefore, option C is incorrect. Options A and B are correct as they align with the strategies typically used in predatory pricing. Option D is incorrect as there are at least two correct statements.

Question 18

Consider a monopolist attempting to engage in limit pricing with total costs C(Q)= 100 + 2Q.The market (inverse)demand for its product is P = 100 − 2Q.Currently,the monopolist produces 30 units of output.Assuming the potential entrant has the same cost structure as the incumbent monopolist,is it profitable for the entrant to produce 10 units of output?
A) Yes, since the market price of $20 is greater than the average total cost of producing 10 units.
B) No, since the market price of $20 is less than the average total cost of producing 10 units.
C) Yes, since the market price of $50 is greater than the average total cost of producing 10 units.
D) No, since the market price of $50 is less than the average total cost of producing 10 units.

Accepted Answer

The average total cost of producing 10 units is (100 + 20) / 10 = 12. The market price of 10 units is 100 - 2(10) = 80. Since 80 > 12, it is profitable for the entrant to produce 10 units of output.

Question 19

Effective limit pricing between one incumbent firm and one potential entrant involves:
A) the incumbent linking the pre-entry price to post-entry profits only.
B) the incumbent reducing price below the monopoly price to prevent entry only.
C) the incumbent linking the pre-entry price to post-entry profits and the incumbent reducing price below the monopoly price to prevent entry.
D) None of the statements are correct.

Accepted Answer

Effective limit pricing between one incumbent firm and one potential entrant involves both linking the pre-entry price to post-entry profits and reducing price below the monopoly price to prevent entry. The incumbent can potentially deter entry by setting a low enough price to prevent the entrant from making a profit even if they enter the market. This is known as linking pre-entry price to post-entry profits. Additionally, if the incumbent reduces price below the monopoly price, it can potentially make it unprofitable for the entrant to enter the market since they would have to price their product lower than the incumbent, leading to lower profits for both firms. Therefore, the best choice is C.

Question 20

If one more user is added to a two-way network,it will generally:
A) benefit the new user more than the existing users.
B) benefit existing users more than the new user.
C) provide equal benefits to existing users and the new user.
D) unable to tell, because this analysis depends on the type of industry.

Accepted Answer

In a two-way network, the addition of a new user increases the potential connections for existing users, thus benefiting them more as they have more people to interact with.

Quiz 13: Advanced Topics in Business Strategy

Limit pricing is:

Under limit pricing,the incumbent will produce:

Which of the following is a correct statement?

A two-way network linking nine users creates how many potential network connections?

Firms that can effectively price discriminate can increase profitability when they engage in:

An example of vertical foreclosure is when a firm:

Suppose the inverse market demand is given by P = 20 − Q.If the incumbent continues to produce eight units of output,which of the following equations best summarizes the potential entrant's residual demand curve?

Firms 1 and 2 compete in a Cournot duopoly.If firm 1 adopts a strategy that raises firm 2's marginal cost:

Which of the following is NOT an example of a network?

A network linking eight users is typically:

Penetration pricing is a way to:

The price-cost squeeze is:

Which of the following is an INCORRECT statement about predatory pricing?

Effective limit pricing between one incumbent firm and one potential entrant involves:

If one more user is added to a two-way network,it will generally: