Chapter 13
Advanced Topics in Business Strategy
Answer: A
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: A
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: D
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
13-1
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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
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.
Answer: D
Learning Objective: 13-03
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: D
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
13-2
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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
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: C
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
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
Learning Objective: 13-01
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 03 Hard
Answer: C
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-3
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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
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
Answer: D
Learning Objective: 13-03
Topic: Predatory Pricing to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-4
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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: B
Learning Objective: 13-03
Topic: Predatory Pricing to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
AACSB: Knowledge Application
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
Learning Objective: 13-03
Topic: Price Discrimination as a Strategic Tool
Blooms: Remember
AACSB: Knowledge Application
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
13-5
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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
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: C
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
AACSB: Knowledge Application
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Understand
AACSB: Knowledge Application Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-6
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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
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.
Answer: C
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
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.
Answer: C
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application Thinking
Difficulty: 03 Hard
13-7
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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
24. A two-way network linking nine users creates how many potential network connections?
A. 72
B. 56
C. 90
D. 18
Answer: A
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 01 Easy
Answer: A
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
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
Answer: B
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 2 Medium
13-8
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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: B
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-9
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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: C
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
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
Learning Objective: 13-03
Topic: Price Discrimination as a Strategic Tool
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-10
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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
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
Answer: C
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: B
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-11
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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: C
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Remember
AACSB: Knowledge Application
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-12
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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
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-13
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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
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
Answer: C
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: B
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-14
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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
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.
Answer: B
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-3
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-15
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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
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
Learning Objective: 13-3
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
13-16
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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
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 01 Easy
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-17
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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
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.
Answer: B
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-18
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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
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-19
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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
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Remember
AACSB: Knowledge Application
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-20
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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
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
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
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
entrant's residual demand curve?
A. P = 130 − 2Q
B. P = 150 − 4Q
C. P = 75 − 0.5Q
D. P = 130 − Q
Answer: A
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
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
Answer: D
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-21
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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: A
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 01 Easy
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.
Answer: D
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
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
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 03 Hard
13-22
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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
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
Low output
High output
A
High output (−$10, −$10)
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
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
13-23
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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: C
Learning Objective: 13-02
Topic: Predatory Pricing to Lessen Competition
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
Answer: C
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Remember
AACSB: Knowledge Application
Difficulty: 01 Easy
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.
Answer: B
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
13-24
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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
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 preceding statements is correct.
Answer: D
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
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 preceding statements is correct.
Answer: A
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
68. A two-way network linking 15 users creates how many potential network connections?
A. 225
B. 100
C. 210
D. 300
Answer: C
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-25
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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
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 preceding statements is correct.
Answer: A
Learning Objective: 13-01
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 03 Hard
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
Answer: A
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: B
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 03 Hard
13-26
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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
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. πL > $200
B. πL > $500
C. πL > $900
D. πL > $1,000
Answer: C
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-27
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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
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 01 Easy
13-28
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Chapter 13 - Advanced Topics in Business Strategy
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.
Answer: A
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-29
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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
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-30
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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
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
Answer: D
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
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
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: A
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
13-31
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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
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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
Answer: B
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
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.
Answer: B
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-32
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Chapter 13 - Advanced Topics in Business Strategy
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.
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 2 Medium
13-33
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Chapter 13 - Advanced Topics in Business Strategy
Player B
Strategy Left Right
Player A
Top $100, $200 −$10, $100
Bottom $500, −$50 −$100, −$100
Left A
Right
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.
Learning Objective: 13-05
Topic: Changing the Timing of Decisions or the Order of Moves
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 3 Hard
13-34
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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
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.
Learning Objective: 13-03
Topic: Raising Rivals’ Costs to Lessen Competition
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-35
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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
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
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.
Learning Objective: 13-01
Topic: Limit Pricing to Prevent Entry
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 03 Hard
13-36
© 2017 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
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
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.
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Apply
AACSB: Analytical Thinking
Difficulty: 01 Easy
13-37
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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
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.
Learning Objective: 13-06
Topic: Penetration Pricing to Overcome Network Effects
Blooms: Evaluate
AACSB: Analytical Thinking
Difficulty: 02 Medium
13-38
© 2017 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.