Question 1

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 2

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 answer of Consider a monopolist attempting to engage in...

Question 3

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 4

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 the incumbent linking the pre-entry price to post-entry profits and the incumbent reducing price below the monopoly price to prevent entry. It is a strategy used by the incumbent firm to deter any potential entrant by reducing the price below the monopoly price. The incumbent firm aims to make it unprofitable for the potential entrant to enter the market. The strategy involves setting a low price so that the entrant does not have any room for profits.

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

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 whether it makes sense for the incumbent to limit price to prevent entry, we need to compare the present value of profits under two scenarios:

Scenario 1: The incumbent maintains its monopoly position and earns $1 million annually. 
Scenario 2: The incumbent limits its price to prevent entry and earns $850,000 annually indefinitely.

First, let's calculate the present value of Scenario 1:

PV = $1,000,000 / 0.05 = $20,000,000

Next, let's calculate the present value of Scenario 2:

PV = $850,000 / 0.05 = $17,000,000

Since $20,000,000 > $17,000,000, it would make sense for the incumbent to limit its price to prevent entry.

Note that the values given in the answer choices ($2 million, $250,000, $5 million) are not relevant to the calculations and are therefore distractions.

Question 7

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 8

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 9

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

An incumbent firm may experience a learning curve that allows it to produce at a lower cost than a potential entrant. This statement is often true and can give the incumbent firm an advantage over potential new entrants to the market.

The other statements are not entirely correct. Predatory pricing can be difficult to prove in court, as it requires evidence of intent to drive out competition. A firm may receive an individual benefit from strategies that raise the marginal costs of its rivals, such as creating a barrier to entry. And an individual firm may benefit from strategies that raise fixed costs if it can spread those costs over a larger output, such as through economies of scale.

Question 10

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

To determine if limit pricing is profitable, we need to compare the profits earned under the two scenarios: with and without entry. 
- Without entry, the incumbent earns a monopoly profit of $10 million. 
- With entry, the incumbent's profit falls to $4 million. 
Thus, the potential loss to the incumbent from entry is ($10 million - $4 million) = $6 million. 
- If the incumbent lowers output to 25,000 units, its profits will be $8 million. Therefore, the profit earned with limit pricing is ($10 million - $8 million) = $2 million. 
At the current interest rate of 210%, the discounted value of $2 million is approximately $1.905 million. This is less than the potential loss of $6 million, so limit pricing is not profitable for the incumbent.

Question 11

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 that controls an essential upstream input, such as a supplier or distributor, refuses to sell to downstream firms that need the input. This can result in competitors being forced out of the market and reduce competition in the industry. This is different from option A, which is an example of predatory pricing, and option B and D, which are examples of horizontal mergers that aim to eliminate competition in the same market.

Question 12

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 of setting a low price for a new product to gain a large market share and attract a large number of customers. The goal of penetration pricing is to quickly establish a product in the market and gain a critical mass of customers. Therefore, the best choice is D, gaining a critical mass of customers.

Question 13

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 of the statements are correct as they are all examples of different types of networks.

Question 14

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

By raising firm 2's marginal cost, firm 1 is reducing the quantity of output that firm 2 can profitably produce. This reduces overall industry supply and drives up prices, leading to higher profits for both firms. However, since firm 2's output is constrained, firm 1 will not necessarily lose market share. Therefore, choices A and B are not correct.

Question 15

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

All of the statements are correct. Effective price discrimination can increase profitability, regardless of the specific strategy used. Limit pricing, vertical foreclosure, and price-cost squeeze are all potential strategies for firms to use when engaging in price discrimination.

Question 16

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 17

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

The answer of If one more user is added to...

Question 18

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

Having its prey stockpile its product would actually harm the firm engaging in predatory pricing as it would lead to excess inventory and potentially lead to a price war with other competitors in the market. Therefore, statement C is incorrect.

Question 19

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 20

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 strategy used by an incumbent firm to discourage potential entrants from entering the market. The incumbent sets a low price, which is below the monopoly price, but is still profitable for the incumbent, thereby making the market less attractive for new players. As a result, potential entrants are less likely to invest in the market, as they will not be able to make enough profits to justify entering the market.

Quiz 13: Advanced Topics in Business Strategy

The price-cost squeeze is:

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

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

Under limit pricing, the incumbent will produce:

Which of the following is a correct statement?

An example of vertical foreclosure is when a firm:

Penetration pricing is a way to:

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

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

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

A network linking eight users is typically:

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

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

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?

Limit pricing is: