You are on page 1of 91

Chapter 13

Advanced Topics in Business Strategy

Multiple Choice Questions

1. Limit pricing will effectively deter entry when:

A. the incumbent links the pre-entry price to post-entry profits.


B. the incumbent has incomplete information.
C. the entrant must commit to enter the market.
D. All of the statements associated with this question are correct.

2. Which of the following is incorrect?

A. Predatory pricing is easy to prove in court.


B. Learning curve effects may enable an incumbent to produce at a lower cost than a potential
entrant.
C. A firm can benefit from strategies that raise the marginal costs of its rivals.
D. A firm can benefit from strategies that raise the fixed costs of all the firms in the industry.

3. Which of the following is an example of a network?

A. Wireless telephone service


B. Railroads
C. Internet
D. All of the examples associated with this question are networks.

13-1
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
4. 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 gain market share.
C. firm 2 will enjoy higher profits.
D. All of the statements associated with this question are correct.

5. A two-way network linking five users creates how many potential network connections?

A. 5
B. 10
C. 20
D. 30

6. Which of the following is FALSE?

A. It is always more profitable to engage in limit pricing than to permit entry.


B. Being the first mover is always best.
C. Engaging in predatory pricing is always more profitable than permitting existing firms to remain
in the market.
D. All of the statements associated with this question are false.

7. Network externalities:

A. may be positive.
B. may be direct.
C. may be indirect.
D. All of the statements associated with this question are correct.

13-2
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
8. Penetration pricing is:

A. a way to raise a rival's marginal cost.


B. a way to raise a rival's fixed cost.
C. a way to overcome an incumbent's first-mover advantage.
D. ineffective in markets with strong networks.

9. A potential entrant knows that it faces a (inverse) residual demand curve given by P = 50 - 4Q.
While the entrant does not know the inverse market demand, it does know that the incumbent
committed to producing 150 units. Using this information, which of the following equations best
summarizes the inverse market demand curve?

A. P = 200 - 4Q
B. P = 200 - Q
C. P = 150 - 4Q
D. None of the statements are correct.

10. A network linking six users is typically:

A. less likely to exhibit bottlenecks than a network linking two users.


B. three times as valuable as a network linking two users.
C. more than three times as valuable as a network linking two users.
D. less than three times as valuable as a network linking two users.

11. In general, adding one more user to a two-way network tends to:

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. not provide any benefit to either new or existing users.

13-3
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
12. Selling a product below cost to gain a foothold in the market in order to eliminate the inefficiencies
introduced by lock-in is known as:

A. predatory pricing.
B. limit pricing.
C. penetration pricing.
D. the price-cost squeeze.

13. Vertical foreclosure is an example of a firm:

A. engaging in a price-cost squeeze.


B. that merges with a rival firm with the intention of eliminating the rival firm's product from the
market.
C. engaging in penetration pricing.
D. that controls an essential upstream input and raises rivals' costs by refusing to sell to other
downstream firms that need the input.

14. A firm that engages in predatory pricing benefits from:

A. building a reputation of accommodating future entrants.


B. building a reputation for taking tough actions to drive a competitor out of the market.
C. having its prey stockpile its product.
D. full protection from the courts.

15. Bottlenecks:

A. occur only in one-way networks.


B. occur only in two-way networks.
C. occur in both one-way and two-way networks.
D. are a positive externality associated with networks.

13-4
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
16. Firms that can effectively price discriminate can increase profitability when they engage in:

A. predatory pricing.
B. limit pricing.
C. strategies that raises rivals' costs.
D. Any of the statements associated with this question are correct.

17. When the average cost curve lies above the entrant's residual demand curve, an entrant:

A. can profitably enter the market.


B. cannot profitably enter the market.
C. is indifferent between entering and not entering the market.
D. lowers the incumbent's average cost curve.

18. Nodes are:

A. examples of positive network externalities.


B. examples of negative network externalities.
C. different points in geographic or economic space linked by a network.
D. None of the statements are correct.

19. Which of the following makes it more difficult for an incumbent to successfully engage in limit
pricing?

A. Complete information
B. Commitment mechanisms
C. Learning curve effects
D. A firm's past reputation for being tough on entrants

13-5
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
20. A single firm that charges the monopoly price in the market earns $500. If another firm successfully
enters the market, the incumbent's profits fall to $325 and the entrant earns $250. 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 < 0.75
B. 0.75 < i < 1.0
C. 1.0 < i < 1.33
D. i > 1.33

21. 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.

22. 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.

13-6
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
23. 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.

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

A. 72
B. 56
C. 90
D. 18

25. 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.

13-7
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
26. 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

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

A. Airlines
B. Trucking
C. Telecommunications
D. None of the statements are correct.

28. 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.

29. 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.

13-8
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
30. 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.

31. 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.

32. 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.

13-9
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
33. 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

34. 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.

35. 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.

36. 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.

13-10
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
37. 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.

38. 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.

13-11
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
39. 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.

40. 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

13-12
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
41. 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 remains a duopolist in this market when
the interest rate is 5 percent.

A. $100 million
B. $200 million
C. $210 million
D. $1.05 billion

42. 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,
answer the following question: If Smyth Industries engages in predatory pricing by slashing its price
50 percent below marginal cost, the present value of current and future profits is:

A. -$100 million.
B. $0.
C. $100 million.
D. $200 million.

13-13
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
43. 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, is
it in Smyth Industries' interest to remain as a duopolist or engage in predatory pricing?

A. Engage in predatory pricing since $210 million is greater than $200 million.
B. Remain as a duopolist since $210 million is greater than $0.
C. Engage in predatory pricing since $1.05 billion is greater than $1 billion.
D. Remain as a duopolist since $210 million is greater than $100 million.

44. Which of the following is NOT an example of raising rivals' fixed costs?

A. Existing doctors in a particular medical field lobby to require new doctors to acquire new
licenses.
B. Yellow Cab Company lobbying New York City government officials for an ordinance that would
require all taxi cab drivers to pay for a medallion, giving them the right to drive a cab in New
York City.
C. Federal Express lobbying the U.S. Department of Transportation to increase annual terminal fees.
D. The New York Port Authority lobbying to increase the tolls on New York City's George
Washington Bridge.

13-14
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
45. Suppose that Microsoft and Google compete in the market for PC Internet browsers. Initially these
firms compete as Cournot duopolies with symmetric reaction functions. If Microsoft enters into
exclusive contracts with PC suppliers that preclude suppliers from loading Google's Internet
browser on PCs loaded with the Windows operating system, then Google's marginal cost of
distributing its browser will increase to $5 per unit.
The new equilibrium would entail Microsoft supplying __________ browsers and Google supplying
____________ browsers to the market. The end result is ________ profits for Google.

A. more; fewer; lower


B. fewer; more; higher
C. more; more; lower
D. fewer; fewer; higher

46. A bottleneck is a:

A. positive externality resulting from network complementarities.


B. negative externality resulting from indirect network externalities.
C. positive externality resulting from congestion beyond the infrastructure capacity.
D. negative externality resulting from congestion beyond the infrastructure capacity.

13-15
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
47. 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.

13-16
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
48. 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 1.

A. Player 1 moves first and plays High Q. Observing player 1's move, player 2's best response is to
play Low Q.
B. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is to
play Low Q.
C. Player 1 moves first and plays High Q. Observing player 1's move, player 2's best response is to
play High Q.
D. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is to
play High Q.

13-17
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
49. 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 Low Q. Observing player 2's move, player 1's best response is to
play Low Q.
B. Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is to
play Low Q.
C. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is to
play High Q.
D. Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is to
play High Q.

13-18
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
50. 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.

51. Refer to the following payoff matrix:

Suppose the simultaneous-move game depicted in the 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. ($15, $30).

13-19
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
52. Suppose that a one-way network leads to the development of a number of new complementary
products and services. This phenomenon is known as:

A. a direct network externality.


B. an indirect network externality.
C. a reputation effect.
D. lock-in.

53. A two-way network that links users and in which the per-unit value of the service increases as the
size of the network increases is a:

A. positive externality known as an indirect network externality.


B. negative externality known as an indirect network externality.
C. positive externality known as a direct network externality.
D. negative externality known as a direct network externality.

54. Consider a two-way network with 1,000 users. Adding one additional user to such a network
benefits all users by adding:

A. 999 potential connections to the network.


B. 1,000 potential connections to the network.
C. 2,000 potential connections to the network.
D. 999,000 potential connections to the network.

55. Consider a two-way network with 1,000 users. The number of potential connections is:

A. 999.
B. 1,000.
C. 2,000.
D. 999,000.

13-20
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
56. Suppose the inverse market demand is given by P = 150 - 2Q. If the incumbent continues to
produce 10 units of output, which of the following equations best summarizes the potential
entrant's residual demand curve?

A. P = 130 - 2Q
B. P = 150 - 4Q
C. P = 75 - 0.5Q
D. P = 130 - Q

57. Suppose the inverse market demand is given by P = 75 - 0.5Q. If the incumbent continues to
produce 20 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 - 2Q
D. P = 65 - 0.5Q

58. Which of the following is the best example of a one-way network?

A. The electricity that flows into residential areas


B. The network of towers that connect cellular telephone users
C. The network that connects instant message users
D. Network using optical fibers carrying signals to and from a subscriber's location

59. 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's reaction function will shift up.


B. firm 2's reaction function will shift up.
C. firm 2's reaction function will shift down.
D. firm 1's reaction function will shift down.

13-21
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
60. Firms 1 and 2 compete in a Cournot duopoly. If firm 2 adopts a strategy that, inadvertently, lowers
firm 1's marginal cost:

A. firm 1's reaction function will shift up.


B. firm 2's reaction function will shift up.
C. firm 2's reaction function will shift down.
D. firm 1's reaction function will shift down.

61. Using the following sequential-move production game, determine whether player B has a first-
mover advantage and identify the strategy that leads to that advantage:

A. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(low output); (if low output, high output), (if high output, high output)}.
B. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(low output); (if low output, high output), (if high output, low output)}.
C. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(high output); (if low output, high output), (if high output, low output)}.
D. Player B does not have a first-mover advantage in the game.

13-22
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
62. 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

63. 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.

64. 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.

65. 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.

13-23
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
66. 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.

67. 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.

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

A. 225
B. 100
C. 210
D. 300

69. 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.

13-24
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
70. 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

71. 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.

72. 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. L > $200
B. L > $500
C. L > $900
D. L > $1,000

13-25
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
73. 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.

74. 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.

13-26
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
75. 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.

13-27
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
76. 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.

13-28
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
77. 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.

78. 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).

13-29
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
79. 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

80. 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

81. 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.

13-30
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
82. A monopolist earns $80 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 $80 million the first period but fall to $35 million annually thereafter. The
opportunity cost of funds is 20 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. $350 million
B. $255 million
C. $400 million
D. $280 million

83. A monopolist earns $80 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 $80 million the first period, but fall to $35 million annually thereafter. The
opportunity cost of funds is 20 percent, and profits in each period are realized at the beginning of
each period. If the monopolist can earn $45 million indefinitely by limit pricing, should it do so?

A. Yes, it will earn $225 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 $225 million in present value if it does this.
D. No, it will earn $270 million in present value if it does this.

Essay Questions

13-31
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
84. A monopolist's demand curve is given by DM and its average cost curve is AC in Figure 13-1.
Suppose a potential entrant can produce at the same cost as the monopolist.
a. What level of output does the monopolist have to produce in order for the entrant to face the
residual demand curve, DR?
b. How much profit will the monopolist earn if it commits to the output that generates the residual
demand curve, DR?
c. Is the level of output that generates the residual demand curve, D R, enough for the monopolist to
deter entry?

13-32
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
85. Consider the following normal-form game.

a. What is player B's best strategy in a simultaneous-move play of this game?


b. What is player A's best strategy in a simultaneous-move play of this game?
c. What are player A and B's equilibrium payoff in a simultaneous-move play of this game?
d. Use an extensive-form representation to show that player B can earn higher payoffs by exercising
a first-mover advantage. (Note: Player B's payoffs will appear first in this extensive-form game since
it is the first mover.)
e. List two things player B must do in order to be able to achieve these higher payoffs.

13-33
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
86. Use Figure 13-3 to answer the following questions.

a. Would firm 1's profit increase or decrease if the equilibrium moved from point A to point B?
b. Would firm 2's profit increase or decrease if the equilibrium moved from point A to point B?
c. As the manager of firm 1, propose a strategy that would increase both the market share and the
profits of firm 1that is, a strategy that moves the market equilibrium from point A to point B.

13-34
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
87. SunCenter is the only firm in its industry. Currently, SunCenter charges $75 per unit, a price well in
excess of its marginal cost of $5 per unit, and earns $70 million per year in profit. According to a
trusted source, the manager of SunCenter learned that a new firm is contemplating entering the
market. This would reduce its profit to $40 million per year. If SunCenter expanded its output and
lowered its price to $50, the entrant would find it unprofitable to enter the market, and SunCenter
would earn profits of $50 million per year for the indefinite future.

a. What pricing strategy is the manager of SunCenter considering?


b. If SunCenter was able to credibly commit to maintain a price of $50, would it be a profitable
strategy? Explain.

13-35
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
88. Sanford Inc. currently competes in a duopoly. The market price is $10, and Sanford's annual profit is
$10 million. If Sanford were the only firm in the market, it could charge the monopoly price of $25
per unit and earn $35 million annually for an indefinite period of time. By charging $5 per unit for
one year, Sanford could drive its rival out of the market and maintain a monopoly position
indefinitely. However, this strategy will result in a $20 million loss since its marginal cost is $8 per
unit.

a. What pricing strategy is the manager considering?


b. Ignoring legal considerations, is this pricing strategy profitable? Assume the interest rate is 5
percent and, for simplicity, that any current period profits or losses occur immediately (at the
beginning of the year).

89. As a newly hired stock analyst, your first job is determining the value of a company that sells a
service that has extremely strong network effects. Essentially, this firm sells a two-way network that
links users and currently comprises 50,000 nodes. Each connection service within the network has a
value of $10. Estimate the total value of the firm.

13-36
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
90. You are the owner of a new network that is superior to an existing two-way network. The network
you aim to replace currently has 50 users, each of whom is willing to pay an average of $75,000 for
each connection service within the current network. You are confident that each user values
connection services within your new two-way network at an average of $100,000 per connection
service.

a. What is the maximum price the existing network can charge each user for its services?
b. Devise a pricing strategy that will permit your firm to overcome the first-mover advantage
enjoyed by the existing network.

13-37
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 13 Advanced Topics in Business Strategy Answer Key

Multiple Choice Questions

1. Limit pricing will effectively deter entry when:

A. the incumbent links the pre-entry price to post-entry profits.


B. the incumbent has incomplete information.
C. the entrant must commit to enter the market.
D. All of the statements associated with this question are correct.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

2. Which of the following is incorrect?

A. Predatory pricing is easy to prove in court.


B. Learning curve effects may enable an incumbent to produce at a lower cost than a potential
entrant.
C. A firm can benefit from strategies that raise the marginal costs of its rivals.
D. A firm can benefit from strategies that raise the fixed costs of all the firms in the industry.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-38
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3. Which of the following is an example of a network?

A. Wireless telephone service


B. Railroads
C. Internet
D. All of the examples associated with this question are networks.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

4. 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 gain market share.
C. firm 2 will enjoy higher profits.
D. All of the statements associated with this question are correct.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

5. A two-way network linking five users creates how many potential network connections?

A. 5
B. 10
C. 20
D. 30

AACSB: Analytic
Blooms: Apply

13-39
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

6. Which of the following is FALSE?

A. It is always more profitable to engage in limit pricing than to permit entry.


B. Being the first mover is always best.
C. Engaging in predatory pricing is always more profitable than permitting existing firms to
remain in the market.
D. All of the statements associated with this question are false.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

7. Network externalities:

A. may be positive.
B. may be direct.
C. may be indirect.
D. All of the statements associated with this question are correct.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-40
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
8. Penetration pricing is:

A. a way to raise a rival's marginal cost.


B. a way to raise a rival's fixed cost.
C. a way to overcome an incumbent's first-mover advantage.
D. ineffective in markets with strong networks.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

9. A potential entrant knows that it faces a (inverse) residual demand curve given by P = 50 - 4Q.
While the entrant does not know the inverse market demand, it does know that the incumbent
committed to producing 150 units. Using this information, which of the following equations best
summarizes the inverse market demand curve?

A. P = 200 - 4Q
B. P = 200 - Q
C. P = 150 - 4Q
D. None of the statements are correct.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Raising Rivals' Costs to Lessen Competition

13-41
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
10. A network linking six users is typically:

A. less likely to exhibit bottlenecks than a network linking two users.


B. three times as valuable as a network linking two users.
C. more than three times as valuable as a network linking two users.
D. less than three times as valuable as a network linking two users.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

11. In general, adding one more user to a two-way network tends to:

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. not provide any benefit to either new or existing users.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

12. Selling a product below cost to gain a foothold in the market in order to eliminate the
inefficiencies introduced by lock-in is known as:

A. predatory pricing.
B. limit pricing.
C. penetration pricing.
D. the price-cost squeeze.

AACSB: Reflective Thinking

13-42
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13. Vertical foreclosure is an example of a firm:

A. engaging in a price-cost squeeze.


B. that merges with a rival firm with the intention of eliminating the rival firm's product from the
market.
C. engaging in penetration pricing.
D. that controls an essential upstream input and raises rivals' costs by refusing to sell to other
downstream firms that need the input.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Predatory Pricing to Lessen Competition

14. A firm that engages in predatory pricing benefits from:

A. building a reputation of accommodating future entrants.


B. building a reputation for taking tough actions to drive a competitor out of the market.
C. having its prey stockpile its product.
D. full protection from the courts.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Predatory Pricing to Lessen Competition

13-43
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
15. Bottlenecks:

A. occur only in one-way networks.


B. occur only in two-way networks.
C. occur in both one-way and two-way networks.
D. are a positive externality associated with networks.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

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

A. predatory pricing.
B. limit pricing.
C. strategies that raises rivals' costs.
D. Any of the statements associated with this question are correct.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Price Discrimination as a Strategic Tool

17. When the average cost curve lies above the entrant's residual demand curve, an entrant:

A. can profitably enter the market.


B. cannot profitably enter the market.
C. is indifferent between entering and not entering the market.
D. lowers the incumbent's average cost curve.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy

13-44
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

18. Nodes are:

A. examples of positive network externalities.


B. examples of negative network externalities.
C. different points in geographic or economic space linked by a network.
D. None of the statements are correct.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

19. Which of the following makes it more difficult for an incumbent to successfully engage in limit
pricing?

A. Complete information
B. Commitment mechanisms
C. Learning curve effects
D. A firm's past reputation for being tough on entrants

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-45
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
20. A single firm that charges the monopoly price in the market earns $500. If another firm
successfully enters the market, the incumbent's profits fall to $325 and the entrant earns $250. 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 < 0.75
B. 0.75 < i < 1.0
C. 1.0 < i < 1.33
D. i > 1.33

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

21. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-46
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
22. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

23. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

13-47
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
24. A two-way network linking nine users creates how many potential network connections?

A. 72
B. 56
C. 90
D. 18

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

25. 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.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

13-48
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
26. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

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

A. Airlines
B. Trucking
C. Telecommunications
D. None of the statements are correct.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-49
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
28. 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.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

29. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-50
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
30. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

31. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-51
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
32. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Price Discrimination as a Strategic Tool

33. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-52
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
34. 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.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

35. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-53
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
36. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

37. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-54
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
38. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

39. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-55
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
40. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-56
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
41. 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 remains a
duopolist in this market when the interest rate is 5 percent.

A. $100 million
B. $200 million
C. $210 million
D. $1.05 billion

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-57
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
42. 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, answer the following question: If Smyth Industries engages in predatory
pricing by slashing its price 50 percent below marginal cost, the present value of current and
future profits is:

A. -$100 million.
B. $0.
C. $100 million.
D. $200 million.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-58
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
43. 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, is it in Smyth Industries' interest to remain as a duopolist or engage in
predatory pricing?

A. Engage in predatory pricing since $210 million is greater than $200 million.
B. Remain as a duopolist since $210 million is greater than $0.
C. Engage in predatory pricing since $1.05 billion is greater than $1 billion.
D. Remain as a duopolist since $210 million is greater than $100 million.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

44. Which of the following is NOT an example of raising rivals' fixed costs?

A. Existing doctors in a particular medical field lobby to require new doctors to acquire new
licenses.
B. Yellow Cab Company lobbying New York City government officials for an ordinance that
would require all taxi cab drivers to pay for a medallion, giving them the right to drive a cab
in New York City.
C. Federal Express lobbying the U.S. Department of Transportation to increase annual terminal
fees.
D. The New York Port Authority lobbying to increase the tolls on New York City's George
Washington Bridge.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.

13-59
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Topic: Raising Rivals' Costs to Lessen Competition

45. Suppose that Microsoft and Google compete in the market for PC Internet browsers. Initially
these firms compete as Cournot duopolies with symmetric reaction functions. If Microsoft enters
into exclusive contracts with PC suppliers that preclude suppliers from loading Google's Internet
browser on PCs loaded with the Windows operating system, then Google's marginal cost of
distributing its browser will increase to $5 per unit.
The new equilibrium would entail Microsoft supplying __________ browsers and Google supplying
____________ browsers to the market. The end result is ________ profits for Google.

A. more; fewer; lower


B. fewer; more; higher
C. more; more; lower
D. fewer; fewer; higher

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

46. A bottleneck is a:

A. positive externality resulting from network complementarities.


B. negative externality resulting from indirect network externalities.
C. positive externality resulting from congestion beyond the infrastructure capacity.
D. negative externality resulting from congestion beyond the infrastructure capacity.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-60
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
47. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-61
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
48. 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 1.

A. Player 1 moves first and plays High Q. Observing player 1's move, player 2's best response is
to play Low Q.
B. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is
to play Low Q.
C. Player 1 moves first and plays High Q. Observing player 1's move, player 2's best response is
to play High Q.
D. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is
to play High Q.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-62
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
49. 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 Low Q. Observing player 2's move, player 1's best response is
to play Low Q.
B. Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is
to play Low Q.
C. Player 1 moves first and plays Low Q. Observing player 1's move, player 2's best response is
to play High Q.
D. Player 2 moves first and plays High Q. Observing player 2's move, player 1's best response is
to play High Q.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-63
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
50. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-64
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
51. Refer to the following payoff matrix:

Suppose the simultaneous-move game depicted in the 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. ($15, $30).

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

52. Suppose that a one-way network leads to the development of a number of new complementary
products and services. This phenomenon is known as:

A. a direct network externality.


B. an indirect network externality.
C. a reputation effect.
D. lock-in.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-65
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
53. A two-way network that links users and in which the per-unit value of the service increases as
the size of the network increases is a:

A. positive externality known as an indirect network externality.


B. negative externality known as an indirect network externality.
C. positive externality known as a direct network externality.
D. negative externality known as a direct network externality.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

54. Consider a two-way network with 1,000 users. Adding one additional user to such a network
benefits all users by adding:

A. 999 potential connections to the network.


B. 1,000 potential connections to the network.
C. 2,000 potential connections to the network.
D. 999,000 potential connections to the network.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-66
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
55. Consider a two-way network with 1,000 users. The number of potential connections is:

A. 999.
B. 1,000.
C. 2,000.
D. 999,000.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

56. Suppose the inverse market demand is given by P = 150 - 2Q. If the incumbent continues to
produce 10 units of output, which of the following equations best summarizes the potential
entrant's residual demand curve?

A. P = 130 - 2Q
B. P = 150 - 4Q
C. P = 75 - 0.5Q
D. P = 130 - Q

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-67
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
57. Suppose the inverse market demand is given by P = 75 - 0.5Q. If the incumbent continues to
produce 20 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 - 2Q
D. P = 65 - 0.5Q

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

58. Which of the following is the best example of a one-way network?

A. The electricity that flows into residential areas


B. The network of towers that connect cellular telephone users
C. The network that connects instant message users
D. Network using optical fibers carrying signals to and from a subscriber's location

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-68
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
59. 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's reaction function will shift up.


B. firm 2's reaction function will shift up.
C. firm 2's reaction function will shift down.
D. firm 1's reaction function will shift down.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

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

A. firm 1's reaction function will shift up.


B. firm 2's reaction function will shift up.
C. firm 2's reaction function will shift down.
D. firm 1's reaction function will shift down.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

13-69
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
61. Using the following sequential-move production game, determine whether player B has a first-
mover advantage and identify the strategy that leads to that advantage:

A. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(low output); (if low output, high output), (if high output, high output)}.
B. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(low output); (if low output, high output), (if high output, low output)}.
C. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage are
{(high output); (if low output, high output), (if high output, low output)}.
D. Player B does not have a first-mover advantage in the game.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-70
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
62. 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

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

63. 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.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

13-71
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
64. 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.

AACSB: Reflective Thinking


Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

65. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

66. 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.

AACSB: Reflective Thinking

13-72
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

67. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

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

A. 225
B. 100
C. 210
D. 300

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-73
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
69. 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.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Raising Rivals' Costs to Lessen Competition

70. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-74
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
71. 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.

AACSB: Reflective Thinking


Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

72. 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. L > $200
B. L > $500
C. L > $900
D. L > $1,000

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-75
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
73. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

74. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-76
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
75. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-77
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
76. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-78
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
77. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-79
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
78. 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).

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

79. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit

13-80
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
from such a strategy.
Topic: Limit Pricing to Prevent Entry

80. 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

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

81. 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.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit

13-81
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
from such a strategy.
Topic: Limit Pricing to Prevent Entry

82. A monopolist earns $80 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 $80 million the first period but fall to $35 million annually
thereafter. The opportunity cost of funds is 20 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. $350 million
B. $255 million
C. $400 million
D. $280 million

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

83. A monopolist earns $80 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 $80 million the first period, but fall to $35 million annually
thereafter. The opportunity cost of funds is 20 percent, and profits in each period are realized at
the beginning of each period. If the monopolist can earn $45 million indefinitely by limit pricing,
should it do so?

A. Yes, it will earn $225 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 $225 million in present value if it does this.
D. No, it will earn $270 million in present value if it does this.

AACSB: Analytic
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit

13-82
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
from such a strategy.
Topic: Limit Pricing to Prevent Entry

Essay Questions

13-83
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
84. A monopolist's demand curve is given by DM and its average cost curve is AC in Figure 13-1.
Suppose a potential entrant can produce at the same cost as the monopolist.
a. What level of output does the monopolist have to produce in order for the entrant to face the
residual demand curve, DR?
b. How much profit will the monopolist earn if it commits to the output that generates the
residual demand curve, DR?
c. Is the level of output that generates the residual demand curve, DR, enough for the
monopolist to deter entry?

a. 25 units
b. Note that P = $175, AC = $75, and Q = 25, so profits are ($175 - $75)(25) = $2,500.
c. No; even if the monopolist could credibly commit to producing 25 units, it is profitable for the
entrant to enter since P > AC for some quantities.

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-84
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
85. Consider the following normal-form game.

a. What is player B's best strategy in a simultaneous-move play of this game?


b. What is player A's best strategy in a simultaneous-move play of this game?
c. What are player A and B's equilibrium payoff in a simultaneous-move play of this game?
d. Use an extensive-form representation to show that player B can earn higher payoffs by
exercising a first-mover advantage. (Note: Player B's payoffs will appear first in this extensive-
form game since it is the first mover.)
e. List two things player B must do in order to be able to achieve these higher payoffs.

a. "Left" is a dominant strategy for Player B.


b. "Bottom," since player A should anticipate that B will play its dominant strategy.
c. ($500, -$50)
d. See the extensive-form game shown in Figure 13-2. Notice that if player B moves first, its best
response is "Right." To see this, notice that if B plays "Left," A will play "Bottom" since $500 is
better than $100. If B plays "Right," A's best response is "Top" since -$10 is better than -$100.
Thus, player B earns a payoff of $100 by moving first and playing "Right," compared to the
payoff of -$50 that is achieved if it does not exercise this first-mover advantage.

13-85
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
e. Player B must be able to credibly commit to the strategy "Right" before player A has a chance
to move. Furthermore, this choice must be known by A before it makes its own move.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 13-05 Assess whether a firm's profits can be enhanced by changing the timing of decisions or the order of
strategic moves; and whether doing so creates first-or second-mover advantages.
Topic: Changing the Timing of Decisions or the Order of Moves

13-86
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
86. Use Figure 13-3 to answer the following questions.

a. Would firm 1's profit increase or decrease if the equilibrium moved from point A to point B?
b. Would firm 2's profit increase or decrease if the equilibrium moved from point A to point B?
c. As the manager of firm 1, propose a strategy that would increase both the market share and
the profits of firm 1that is, a strategy that moves the market equilibrium from point A to point
B.

a. Increase
b. Decrease
c. Raise firm 2's marginal cost.

AACSB: Analytic
Blooms: Analyze
Difficulty: 2 Medium
Learning Objective: 13-03 Show how a manager can profitably lessen competition by raising rivals' costs.
Topic: Raising Rivals' Costs to Lessen Competition

13-87
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
87. SunCenter is the only firm in its industry. Currently, SunCenter charges $75 per unit, a price well
in excess of its marginal cost of $5 per unit, and earns $70 million per year in profit. According
to a trusted source, the manager of SunCenter learned that a new firm is contemplating
entering the market. This would reduce its profit to $40 million per year. If SunCenter expanded
its output and lowered its price to $50, the entrant would find it unprofitable to enter the
market, and SunCenter would earn profits of $50 million per year for the indefinite future.

a. What pricing strategy is the manager of SunCenter considering?


b. If SunCenter was able to credibly commit to maintain a price of $50, would it be a profitable
strategy? Explain.

a. Limit pricing. It is not predatory pricing since there is currently no firm in the market, and the
proposed price is above its marginal cost.
b. Assuming the firm can credibly commit to maintain the price of $50, limit pricing is profitable

if or in this case, . Simplifying, we see that

limit pricing is profitable if Solving for i, it follows that limit pricing is profitable if i
< 0.5. That is, so long as the interest rate is less than 50 percent, limit pricing is a profitable
strategy.

AACSB: Analytic
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 13-01 Explain the economic basis for limit pricing; and identify the conditions under which a firm can profit
from such a strategy.
Topic: Limit Pricing to Prevent Entry

13-88
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
88. Sanford Inc. currently competes in a duopoly. The market price is $10, and Sanford's annual
profit is $10 million. If Sanford were the only firm in the market, it could charge the monopoly
price of $25 per unit and earn $35 million annually for an indefinite period of time. By charging
$5 per unit for one year, Sanford could drive its rival out of the market and maintain a monopoly
position indefinitely. However, this strategy will result in a $20 million loss since its marginal cost
is $8 per unit.

a. What pricing strategy is the manager considering?


b. Ignoring legal considerations, is this pricing strategy profitable? Assume the interest rate is 5
percent and, for simplicity, that any current period profits or losses occur immediately (at the
beginning of the year).

a. Predatory pricing
b. If Sanford does not engage in predatory pricing, the present value of its earnings (including
current earnings of $10 million) is

= (21)($10)
=$210 million

If Sanford uses predatory pricing, the present value of its current and future profits is

= -$20 + $700
=$680 million

In this case, Sanford earns more by predatory pricing.

AACSB: Analytic

13-89
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 13-02 Explain the economic basis for predatory pricing.
Topic: Predatory Pricing to Lessen Competition

89. As a newly hired stock analyst, your first job is determining the value of a company that sells a
service that has extremely strong network effects. Essentially, this firm sells a two-way network
that links users and currently comprises 50,000 nodes. Each connection service within the
network has a value of $10. Estimate the total value of the firm.

With 50,000 nodes, the total number of potential connection services is 2,499,950,000,
computed as 50,000(49,999). Since each of these connection services is valued at $10, the total
value of the network is $24,999,500,000, or almost $25 billion.

AACSB: Analytic
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-90
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
90. You are the owner of a new network that is superior to an existing two-way network. The
network you aim to replace currently has 50 users, each of whom is willing to pay an average of
$75,000 for each connection service within the current network. You are confident that each user
values connection services within your new two-way network at an average of $100,000 per
connection service.

a. What is the maximum price the existing network can charge each user for its services?
b. Devise a pricing strategy that will permit your firm to overcome the first-mover advantage
enjoyed by the existing network.

a. The existing network provides 50(49) = 2,450 potential connection services. Since each
consumer values connection services at an average of $75,000 per connection, the total value to
each consumer of the existing network is $183,750,000. Thus, the maximum amount a user
would pay to use the existing network is $183,750,000.
b. Notice that the maximum amount each user will pay for access to the new network is
$245,000,000 (since 2,450 $100,000 = $245,000,000). However, a user will only pay this
amount if all 50 users subscribe to the new network! To get all users to switch, the owner of the
new network should consider a penetration pricing strategy. Examples include initially giving
services away for free or even paying a small amount to induce users to switch to the new
network. Once all users switch, the price can be increased to $245,000,000 per user.

AACSB: Analytic
Blooms: Evaluate
Difficulty: 2 Medium
Learning Objective: 13-06 Identify examples of networks and network externalities; and determine the number of connections
possible in a star network with n users.
Topic: Penetration Pricing to Overcome Network Effects

13-91
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.