Multiple Choice

Multiple Choice

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1. 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 device 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.

Compute the present value of Smyth Industries’ profits, if it could have remained a monopoly, and the present value of Smyth Industries’ profits if it remains a duopolist in this market, given the interest rate is 5 percent.

A) $250 million; $110 million.

B) $210 million; $100 million.

C) $210 million; $200 million.

D) $1.5 billion; $420 million.

E) $1.05 billion; $210 million.

2.  In the problem above, Smyth Industries is deciding whether it should engage in predatory pricing by slashing its price 50 percent below marginal cost, or remain as a duopolist. What do you suggest? hint: the present value of current and future profits from predatory pricing and duopoly.

A) Engage in predatory pricing since $210 million is greater than $200 million.

B) Engage in predatory pricing since $1.05 billion is greater than $1 billion.

C) Remain as a duopolist since $210 million is greater than $0.

D) Remain as a duopolist since $210 million is greater than $100 million.

E) The two options lead to the same profits.

3. 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 out where it is earning $850,000 annually for the indefinite future. If the interested rate is 5 percent, does it make sense for the incumbent to limit price to prevent entry?

A) Yes, since $2 million > $150,000.

B) Yes, since $250,000 $250,000.

D) Yes, since $850 million > $750,000.

E) The firm is indifferent, because $2 million = $2 million.

4. Consider an incumbent successfully links the preentry price and postentry profit to prevent entry. The incumbent’s monopoly profit is $10 million. If a rival successfully enters the market, the incumbent’s profits will fall to $4 million. If the incumbent lowers output to 25,000 units, its rival will stay out of the market resulting in an infinite stream of profits of $8 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 $4 million is less than $4.2 million.

C) No, since $1.91 million is less than $2 million.

D) Yes, since $8 million is greater than $4 million.

E) Linking the preentry price to the postentry profit is sufficient to guarantee the profitability of limit pricing.