Baye 9e - Chapter 13 - TB

Chapter 13 - Advanced Topics in Business Strategy
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.
Answer: A
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
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.
Answer: A
Topic: Predatory Pricing to Lessen Competition
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: D
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
Difficulty: 01 Easy
13-1
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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.
Answer: D
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application Difficulty: 02 Medium
5. A two-way network linking five users creates how many potential network connections?
A. 5
B. 10
C. 20
D. 30
Answer: C
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: D
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Understand
7. Network externalities:
A. may be positive.
B. may be direct.
C. may be indirect.
Answer: D
13-2
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: C
Blooms: Understand
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.
Answer: D
Blooms: Analyze
Difficulty: 03 Hard
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.
Answer: C
Blooms: Apply
13-3
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.
Answer: B
Blooms: Understand
Difficulty: 03 Hard
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.
Answer: C
Blooms: Understand
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.
Answer: D
Blooms: Understand
13-4
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.
Answer: B
Blooms: Understand
Difficulty: 03 Hard
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: D
Topic: Price Discrimination as a Strategic Tool
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: B
13-5
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
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
Answer: A
Blooms: Understand
AACSB: Knowledge Application Thinking
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
Answer: A
Blooms: Apply
13-6
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.
Answer: C
Blooms: Understand
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.
Answer: B
Blooms: Understand
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.
Answer: C
Blooms: Understand
Difficulty: 03 Hard
13-7
24. A two-way network linking nine users creates how many potential network connections?
A. 72
B. 56
C. 90
D. 18
Answer: A
Blooms: Apply
Difficulty: 01 Easy
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.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
A. i > 4
B. i < 0.25
C. 0.75 < i < 4
D. 0.25 < i < 0.75
Answer: B
Blooms: Apply
13-8
27. Which of the following is NOT an example of a network?

A. Airlines
B. Trucking
C. Telecommunications
Answer: D
Blooms: Remember
AACSB: Knowledge Application T
Difficulty: 01 Easy
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.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: B
Blooms: Understand
13-9
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.
Answer: C
Blooms: Understand
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.
Answer: C
Blooms: Understand
Difficulty: 01 Easy
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.
Answer: D
Topic: Price Discrimination as a Strategic Tool
Blooms: Understand
13-10
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
Answer: A
Blooms: Apply
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: B
Blooms: Understand
13-11
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: A
Blooms: Apply
Difficulty: 03 Hard
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.
Answer: B
Blooms: Apply
13-12
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.
Answer: B
Blooms: Apply
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
Answer: D
Blooms: Apply
13-13
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
Answer: C
Blooms: Apply
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.
Answer: B
Blooms: Apply
Difficulty: 03 Hard
13-14
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.
Answer: B
Blooms: Apply
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.
Answer: D
Blooms: Understand
13-15
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
Answer: A
Blooms: Understand
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.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
47. Refer to the following payoff matrix:

Player 2
Low Q High Q
Low Q $50, $5 $15, $30

Player 1
High Q $40, $2 $2, $1
13-16
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.
Answer: C
Blooms: Apply
Difficulty: 01 Easy

Player 2
Low Q High Q
Low Q $50, $5 $15, $30

Player 1
High Q $40, $2 $2, $1
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.
Answer: A
Blooms: Apply
Difficulty: 03 Hard
13-17

Player 2
Low Q High Q
Low Q $50, $5 $15, $30

Player 1
High Q $40, $2 $2, $1
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.
Answer: B
Blooms: Apply

Player 2
a b
A $50, $5 $15, $30

Player 1
B $40, $2 $20, $1
13-18
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.
Answer: D
Blooms: Apply

Player 2
a b
A $50, $5 $15, $30

Player 1
B $40, $2 $20, $1
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)
Answer: C
Blooms: Apply
Difficulty: 03 Hard
13-19
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.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: C
Blooms: Understand
Difficulty: 01 Easy
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.
Answer: B
Blooms: Understand
13-20
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.
Answer: D
Blooms: Apply
Difficulty: 01 Easy
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
A. P = 130 − 2Q
B. P = 150 − 4Q
C. P = 75 − 0.5Q
D. P = 130 − Q
Answer: A
Blooms: Apply
Difficulty: 03 Hard
57. Suppose the inverse market demand is given by P = 75 − 0.5Q. If the incumbent continues
A. P = 65 − 2Q
B. P = 20 − 0.5Q
C. P = 150 − 2Q
D. P = 65 − 0.5Q
Answer: D
Blooms: Apply
Difficulty: 03 Hard
13-21
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
Answer: A
Blooms: Understand
Difficulty: 01 Easy
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.
Answer: D
Blooms: Understand
Difficulty: 03 Hard
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.
Answer: A
Blooms: Understand
Difficulty: 03 Hard
13-22
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:
Low output ($20, $10)
A
Low output
High output (−$5, $50)

B
Low output ($10, −$1)
High output
A
High output (−$10, −$10)
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.
Answer: C
Blooms: Apply
Difficulty: 03 Hard
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
Answer: A
Blooms: Remember
Difficulty: 01 Easy
13-23
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
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.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
1's marginal cost:
B. firm 2 will gain market share.
C. firm 2 will enjoy lower profits.
Answer: B
Blooms: Understand
13-24
1's marginal cost:
D. None of the preceding statements is correct.
Answer: D
Blooms: Understand
1's marginal cost:
A. firm 1 will reduce its output.
C. firm 2 will enjoy lower profits.
Answer: A
Blooms: Understand
68. A two-way network linking 15 users creates how many potential network connections?
A. 225
B. 100
C. 210
D. 300
Answer: C
Blooms: Apply
13-25
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
Answer: A
Blooms: Analyze
Difficulty: 03 Hard
A. i < 0.5
B. 0.5 < i < 1.0
C. 1.0 < i < 1.5
D. i > 1.5
Answer: A
Blooms: Apply
2's marginal cost:
B. firm 1 will increase market share.
C. firm 1 will suffer lower profits.
Answer: B
Blooms: Understand
Difficulty: 03 Hard
13-26
72. A single firm that charges the monopoly price in the market earns $1,300. If another firm
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. πL > $200
B. πL > $500
C. πL > $900
D. πL > $1,000
Answer: C
Blooms: Apply
Difficulty: 03 Hard
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.
Answer: A
Blooms: Apply
Difficulty: 03 Hard
13-27
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.
Answer: B
Blooms: Apply

Player 2
Low Q High Q
Low Q $10, $35 $25, $30

Player 1
High Q $30, $7 $20, $6
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.
Answer: D
Blooms: Apply
Difficulty: 01 Easy
13-28

Player 2
Low Q High Q
Low Q $10, $35 $25, $30

Player 1
High Q $30, $7 $20, $6
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.
Answer: A
Blooms: Apply
Difficulty: 03 Hard

Player 2
a b
A $50, $5 $25, $30

Player 1
B $40, $2 $20, $1
13-29
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.
Answer: C
Blooms: Apply

Player 2
a b
A $50, $5 $25, $30

Player 1
B $40, $2 $20, $1
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)
Answer: C
Blooms: Apply
Difficulty: 03 Hard
13-30
79. Suppose the inverse market demand is given by P = 105 − Q. If the incumbent continues
A. P = 65 − 2Q
B. P = 20 − 0.5Q
C. P = 150 − Q
D. P = 65 − Q
Answer: D
Blooms: Apply
Difficulty: 03 Hard
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
Answer: A
Blooms: Apply
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.
Answer: A
13-31
Blooms: Apply
incumbent's profits remain at $80 million the first period but fall to $35 million annually
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
Answer: B
Blooms: Apply
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.
Answer: B
Blooms: Apply
13-32
Essay Questions
84. A monopolist's demand curve is given by DM and its average cost curve is AC as shown
here. 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?
Answer:
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.
Blooms: Analyze
13-33
85. Consider the following normal-form game.
Player B
Strategy Left Right
Player A
Top $100, $200 −$10, $100
Bottom $500, −$50 −$100, −$100
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.
Answer:
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 the figure below. 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.
Top ($200, $100)
Left A
Bottom (−$50, $500)
Top B ($100, −$10)
Right
Bottom (−$100, −$100)

A
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.
Blooms: Analyze
Difficulty: 3 Hard
13-34
86. Use figure below to answer the following questions.
Q2
r1
B
b a
P 1 P 1
r* 2
r2
QM 1 Q1
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 1—that is, a strategy that moves the market equilibrium from point A to
point B.
Answer:
a. Increase
b. Decrease
c. Raise firm 2's marginal cost.
Blooms: Analyze
13-35
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.
Answer:
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.
Blooms: Analyze
Difficulty: 03 Hard
13-36
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).
Answer:
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.

Blooms: Apply
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.
Answer:
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.
Blooms: Apply
Difficulty: 01 Easy
13-37
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.
Answer:
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.
Blooms: Evaluate
13-38

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Chapter 13 - Advanced Topics in Business Strategy

Multiple Choice Questions

1. Limit pricing will effectively deter entry when:

2. Which of the following is incorrect?

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

6. Which of the following is FALSE?

8. Penetration pricing is:

10. A network linking six users is typically:

13. Vertical foreclosure is an example of a firm:

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

18. Nodes are:

22. Which of the following is a correct statement?

25. The price–cost squeeze is:

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

28. Penetration pricing is a way to:

29. A network linking eight users is typically:

30. An example of vertical foreclosure is when a firm:

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

34. Limit pricing is:

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

36. Under limit pricing, the incumbent will produce:

47. Refer to the following payoff matrix:

Low Q $50, $5 $15, $30

48. Refer to the following payoff matrix:

Low Q $50, $5 $15, $30

49. Refer to the following payoff matrix:

Low Q $50, $5 $15, $30

50. Refer to the following payoff matrix:

A $50, $5 $15, $30

51. Refer to the following payoff matrix:

A $50, $5 $15, $30

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

Low output ($20, $10)

High output (−$5, $50)

A. Player B has a first-mover advantage. The equilibrium strategies leading to an advantage

63. Predatory pricing is a strategy:

64. A price–cost squeeze is a tactic used:

75. Refer to the following payoff matrix:

Low Q $10, $35 $25, $30

76. Refer to the following payoff matrix:

Low Q $10, $35 $25, $30

77. Refer to the following payoff matrix:

A $50, $5 $25, $30

78. Refer to the following payoff matrix:

A $50, $5 $25, $30

85. Consider the following normal-form game.

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

Top ($200, $100)

Bottom (−$50, $500)

Top B ($100, −$10)

Bottom (−$100, −$100)

86. Use figure below to answer the following questions.

or in this case, . Simplifying, we see that limit pricing is

In this case, Sanford earns more by predatory pricing.

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