Question 1

Predatory pricing is a strategy:
A) whereby an incumbent maintains a price below the monopoly level to prevent entry by potential competitors.
B) whereby a firm enjoys lower costs due to knowledge gained from its past production decisions.
C) whereby a firm temporarily prices below its marginal cost to drive competitors out of the market.
D) used by a vertically integrated firm to squeeze the margins of its competitors.

Accepted Answer

Predatory pricing is the strategy wherein a firm temporarily prices below its marginal cost to drive competitors out of the market. This will lead to lower market share and monopoly power of the firm in the long run. It is illegal in some countries since it affects the free market competition.

Question 2

Consider an incumbent that is a monopoly currently earning $2 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 $1.2 million annually. To keep potential entrants out of the market, the incumbent lowers its price to the point where it is earning $1.6 million annually for the indefinite future. If the interest rate is 10 percent, does it make sense for the incumbent to limit price to prevent entry?
A) No, since $4 million > $400,000.
B) Yes, since $4 million > $400,000.
C) No, since $2 million > $200,000.
D) Yes, since $2 million > $200,000.

Accepted Answer

To determine if it makes sense for the incumbent to limit price to prevent entry, we need to compare the profits the incumbent would earn if it limited price to the profits it would earn if it didn't limit price and a new entrant successfully entered the market.

If the incumbent limits price, it will earn $1.6 million annually indefinitely. This has a present value of:

PV = $1.6 million / 0.1 = $16 million

If the incumbent doesn't limit price and a new entrant enters the market, the incumbent's profits would be reduced to $1.2 million annually. This has a present value of:

PV = $1.2 million / 0.1 = $12 million

However, if the incumbent limited price and a new entrant still entered the market, the incumbent's profits would be reduced to $1.2 million annually indefinitely. This has a present value of:

PV = $1.2 million / 0.1 = $12 million

Comparing the present values, we see that limiting price gives the incumbent the highest present value of profits at $16 million, which is greater than the $12 million it would earn if a new entrant successfully entered the market. Therefore, it makes sense for the incumbent to limit price to prevent entry. Choice B is the correct answer.

Question 3

A single firm that charges the monopoly price in the market earns $1,300. If another firm successfully enters the market, the incumbent's profits fall to $700 and the entrant earns $575. If the interest rate is 0.5, how high must the firm's profits from limit pricing be for limit pricing to be a profitable strategy for the incumbent? A) π^L > $200 B) π^L > $500 C) π^L > $900 D) π^L > $1,000

Accepted Answer

To determine whether limit pricing is a profitable strategy for the incumbent, we need to compare the profits earned from limit pricing to the profits earned under the scenario where a new entrant successfully enters the market. Under limit pricing, the incumbent firm sets its price at P0 to deter entry, earning profits of πS1LS1P0. If a new entrant successfully enters the market, the incumbent's profits fall to $700 while the entrant earns $575. Therefore, the total profits earned in the market would be $1,275 ($700 + $575). Given an interest rate of 0.5, the value of these profits in current dollars is: PV = $1,275 / (1 + 0.5) = $850 For limit pricing to be a profitable strategy, the incumbent's profits from limit pricing must be greater than the profits earned under the scenario where a new entrant successfully enters the market. Therefore, we need to solve for: πS1LS1P0 > $850 πS1LS1P0 > $850 / (1 - μ) = $850 / (1 - 0.5) = $1,700 Therefore, the best choice is C, π^L > $900.

Question 4

Which of the following is a strategy that can be used only by vertically integrated firms?
A) Vertical foreclosure
B) Predatory pricing
C) Limit pricing
D) Penetration pricing

Accepted Answer

Vertical foreclosure is a strategy used by vertically integrated firms to prevent their rivals from accessing inputs or customers, thereby reducing competition. This can only be done by firms that control both upstream and downstream operations.

Question 5

Refer to the following payoff matrix:  The Nash equilibrium for the simultaneous-move game depicted in the payoff matrix is:
A) {(A,a) and (A,b)}.
B) {(A,a)}.
C) {B,b)}.
D) There is no pure strategy Nash equilibrium to this game.

Accepted Answer

The answer of Refer to the following payoff matrix: ...

Question 6

A two-way network linking 15 users creates how many potential network connections?
A) 225
B) 100
C) 210
D) 300

Accepted Answer

Each user can potentially connect with 14 others (since they cannot connect to themselves or to someone they are already connected to), so there are 15 options for the first user, 14 options for the second user, 13 for the third, and so on. This results in a total of 15 x 14 x 13 x...x 2 x 1, which equals 15! (15 factorial). However, since the order in which the connections are made does not matter (i.e. A connecting with B and then B connecting with A is the same as B connecting with A and then A connecting with B), we need to divide by the number of possible arrangements of the 15 users, which is 15 x 14 x 13 x...x 2 x 1 (i.e. another 15 factorial). This gives us a final answer of (15!)/(15! x 15!), which simplifies to 105, or 210 potential connections.

Question 7

Refer to the following payoff matrix:  Suppose the production game depicted in the payoff matrix is a sequential-move game. Identify the strategy leading to a first-mover advantage for player 2.
A) Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is to play Low Q.
B) Player 2 moves first and plays Low Q. Observing player 2's move, player 1's best response is to play Low Q.
C) Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is to play High Q.
D) Player 2 moves first and plays Low Q. Observing player 2's move, player 1's best response is to play High Q.

Accepted Answer

The answer of Refer to the following payoff matrix: ...

Question 8

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. What is the present value of the firm's current and future earnings if entry occurs?
A) $300 million
B) $250 million
C) $400 million
D) $500 million

Accepted Answer

The answer of A monopolist earns $50 million annually and...

Question 9

A potential entrant knows that it faces a (inverse) residual demand curve given by P = 90 - 3Q. While the entrant does not know the inverse market demand, it does know that the incumbent committed to producing 10 units. Using this information, which of the following equations best summarizes the inverse market demand curve?
A) P = 60 - 3Q
B) P = 80 - 3Q
C) P = 50 - 3Q
D) None of the statements is correct.

Accepted Answer

The inverse market demand curve is P = 90 - 3Q. The incumbent committed to producing 10 units, so the residual demand curve faced by the potential entrant is P = 90 - 3Q - 3(10) = 60 - 3Q.

Question 10

Refer to the following payoff matrix:  If the payoff matrix is a simultaneous-move production game, the Nash equilibrium is for:
A) both players to produce low output.
B) both players to produce high output.
C) player 1 to produce low output and player 2 to produce high output.
D) player 1 to produce high output and player 2 to produce low output.

Accepted Answer

The answer of Refer to the following payoff matrix: ...

Question 11

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.

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).

Question 12

Suppose the inverse market demand is given by P = 105 - Q. If the incumbent continues to produce 40 units of output, which of the following equations best summarizes the potential entrant's residual demand curve?
A) P = 65 - 2Q
B) P = 20 - 0.5Q
C) P = 150 - Q
D) P = 65 - Q

Accepted Answer

To find the potential entrant's residual demand curve, we need to subtract the incumbent's output from the inverse market demand function.

So, with the incumbent producing 40 units, the new demand function becomes:

P = 105 - (40 + Q)
P = 65 - Q

Therefore, the potential entrant's residual demand curve is given by choice D, P = 65 - Q.

Question 13

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 increase market share.
C) firm 1 will suffer lower profits.
D) All of the statements associated with this question are correct.

Accepted Answer

When Firm 1 adopts a strategy that raises Firm 2's marginal cost, Firm 2 will produce less, allowing Firm 1 to increase its market share.

Question 14

Consider a monopolist attempting to engage in limit pricing with total costs C(Q) = 200 + 10Q. The market (inverse) demand for its product is P = 150 - 2Q. Currently, the monopolist produces 40 units of output. Assuming the potential entrant has the same cost structure as the incumbent monopolist, is it profitable for the entrant to produce 20 units of output?
A) Yes, since the market price of $30 is greater than the average total cost of producing 20 units.
B) No, since the market price of $30 is less than the average total cost of producing 20 units.
C) Yes, since the market price of $70 is greater than the average total cost of producing 20 units.
D) No, since the market price of $70 is less than the average total cost of producing 20 units.

Accepted Answer

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

Question 15

Refer to the following payoff matrix:  Suppose the simultaneous-move game depicted in this payoff matrix could be turned into a sequential-move game with player 1 moving first. In this case, the equilibrium payoffs will be:
A) ($20, $1).
B) ($50, $5).
C) ($40, $2).
D) ($25, $30).

Accepted Answer

The answer of Refer to the following payoff matrix: ...

Question 16

A price-cost squeeze is a tactic used:
A) to prevent potential competitors from entering a market.
B) by a vertically integrated firm to squeeze the margins of its competitors.
C) by a vertically integrated firm to charge downstream rivals a prohibitive price for an essential input, forcing rivals to use more costly substitutes or exit the industry.
D) to gain a critical mass of consumers by charging an initial low price.

Accepted Answer

A price-cost squeeze is when a vertically integrated firm charges downstream competitors a prohibitively high price for an essential input, thereby squeezing their margins and potentially pushing them out of the market. This is done because the vertically integrated firm is often the sole or dominant supplier of the essential input, giving it significant pricing power. This tactic is not used to prevent potential competitors from entering the market or to gain a critical mass of consumers by charging an initial low price.

Question 17

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

Accepted Answer

In a Cournot duopoly, if firm 2 adopts a strategy that increases firm 1's marginal cost, firm 1 will produce less, leading to firm 2 gaining market share as it can capture the portion of the market that firm 1 loses due to its increased costs.

Question 18

Firms 1 and 2 compete in a Cournot duopoly. If firm 2 adopts a strategy that raises firm 1's marginal cost:
A) firm 1 will increase its output.
B) firm 2 will lose market share.
C) firm 1 will enjoy higher profits.
D) None of the statements is correct.

Accepted Answer

In a Cournot duopoly, if firm 2 raises firm 1's marginal cost, firm 1 will likely reduce its output, leading to a potential increase in firm 2's market share and profits, not firm 1's.

Question 19

Firms 1 and 2 compete in a Cournot duopoly. If firm 2 adopts a strategy that raises firm 1's marginal cost:
A) firm 1 will reduce its output.
B) firm 2 will lose market share.
C) firm 2 will enjoy lower profits.
D) None of the statements is correct.

Accepted Answer

If firm 2 raises firm 1's marginal cost, it will reduce firm 1's profit potential. In order to maximize their profits, firm 1 will reduce its output to account for the higher costs. Thus, choice A is the best answer. Choice B is not necessarily true since we do not know the market conditions, and it is possible that firm 2 may still maintain its market share even if firm 1 reduces its output. Choice C is also not necessarily true since we do not know the overall impact on firm 2's profits.

Question 20

A single firm that charges the monopoly price in the market earns $800. If another firm successfully enters the market, the incumbent's profits fall to $500 and the entrant earns $450. If the incumbent engages in limit pricing, its profits are $600. For what interest rate, i, is limit pricing a profitable strategy for the incumbent?
A) i < 0.5
B) 0.5 < i < 1.0
C) 1.0 < i < 1.5
D) i > 1.5

Accepted Answer

If the incumbent continues to charge the monopoly price, its profits will be $800. 
If the entrant successfully enters the market, the incumbent's profits fall to $500 and the entrant earns $450. Together, they earn $950. 
If the incumbent engages in limit pricing, its profits are $600, while the entrant earns $0.

Therefore, the incumbent's decision is between earning $600 (limit pricing) or $500 (if the entrant successfully enters the market). 
The incumbent's profit if it continues to charge the monopoly price is irrelevant since the question asks about the profitability of limit pricing.

We can set up an equation to solve for the critical interest rate:

$600 = $500/(1+i) + $450(1/(1+i))
Solving for i, we get i = 0.5, which is less than the interest rate on investment.

Therefore, limit pricing is a profitable strategy for the incumbent at an interest rate less than 0.5. The answer is A.

Quiz 13: Advanced Topics in Business Strategy

Predatory pricing is a strategy:

Which of the following is a strategy that can be used only by vertically integrated firms?

Refer to the following payoff matrix: The Nash equilibrium for the simultaneous-move game depicted in the payoff matrix is:

A two-way network linking 15 users creates how many potential network connections?

Refer to the following payoff matrix: Suppose the production game depicted in the payoff matrix is a sequential-move game. Identify the strategy leading to a first-mover advantage for player 2.

Refer to the following payoff matrix: If the payoff matrix is a simultaneous-move production game, the Nash equilibrium is for:

Suppose the inverse market demand is given by P = 105 - Q. If the incumbent continues to produce 40 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:

Refer to the following payoff matrix: Suppose the simultaneous-move game depicted in this payoff matrix could be turned into a sequential-move game with player 1 moving first. In this case, the equilibrium payoffs will be:

A price-cost squeeze is a tactic used:

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

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

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