#1

Barnacle Industries was awarded a patent over 15 years ago for a unique industrial strength cleaner
that removes barnacles and other particles from the hulls of ships. Thanks to its monopoly position,
Barnacle has earned more than $160 million over the past decade. Its customersspanning the
gamut from cruise lines to freightersuse the product because it reduces their fuel bills. The annual
(inverse) demand function for Barnacles product is given by P = 350 -0.00008Q, and Barnacles
cost function is given by C(Q) = 270Q. Thanks to subsidies stemming from an energy bill passed by
Congress nearly two decades ago, Barnacle does not have any fixed costs: The federal government
essentially pays for the plant and capital equipment required to make this energy-saving product.
Absent this subsidy, Barnacles fixed costs would be about $8 million annually. Knowing that the
companys patent will soon expire, Marge, Barnacles manager, is concerned that entrants will
qualify for the subsidy, enter the market, and produce a perfect substitute at an identical cost. With
interest rates at 5 percent, Marge is considering a limit-pricing strategy.
What would Barnacle's profits be if Marge pursues a limit-pricing strategy if the subsidy is in place?
$

Instruction: Round all answers to the nearest penny (two decimal places).
What would Barnacle's profits be if Marge convinces the government to eliminate the subsidy?
$

What would be the profit of a new entrant if the subsidy is eliminated and Barnacle continues to
produce the monopoly level of output?
$

Which strategy is more beneficial to Barnacle?

Eliminating the subsidy and continuing to produce the monopoly output
Limit pricing

#2
Suppose that, prior to other firms entering the market, the maker of a new smartphone (Way Cool,
Inc.) earns $75 million per year. By reducing its price by 55 percent, Way Cool could discourage
entry into its market, but doing so would cause its profits to sink to $6 million. By pricing such that
other firms would be able to enter the market, Way Cools profits would drop to $35 million for the
indefinite future.
In light of these estimates, do you think it is profitable for Way Cool to engage in limit pricing?
Yes - limit pricing is profitable.
More information is needed to answer this question.
No - limit pricing is not profitable.

#3
Two firms compete in a homogeneous product market where the inverse demand function is P = 10
-2Q (quantity is measured in millions). Firm 1 has been in business for one year, while Firm 2 just
recently entered the market. Each firm has a legal obligation to pay one years rent of $0.4 million
regardless of its production decision. Firm 1s marginal cost is $2, and Firm 2s marginal cost is $6.
The current market price is $8 and was set optimally last year when Firm 1 was the only firm in the
market. At present, each firm has a 50 percent share of the market.
a. Based on the information above, what is the likely reason that Firm 1s marginal cost is lower than
Firm 2s marginal cost?
Learning curve effects
Limit pricing
Second-mover advantage
Direct network externality

b. Determine the current profits of the two firms.

Instruction: Round all answers to the nearest penny (two decimal places).
Firm 1's profits: $

million

Firm 2's profits: $

million

c. What would each firms current profits be if Firm 1 reduced its price to $6 while Firm 2 continued to
charge $8?

Instruction: Round all answers to the nearest penny (two decimal places).
Firm 1's profits: $

million

Firm 2's profits: $

million

d. Suppose that, by cutting its price to $6, Firm 1 is able to drive Firm 2 completely out of the market.
After Firm 2 exits the market, does Firm 1 have an incentive to raise its price?
Yes
No

e. Is Firm 1 engaging in predatory pricing when it cuts its price from $8 to $6?
(Click to select)

#4
A firm is considering building a two-way network that links 12 users. The cost of building the network
is $9,000.
a. How many potential connection services does this network provide?
connection services

b. If each user is willing to pay $100 to connect to the network, will the firm profit by building the
network?
(Click to select)

c. If each user is willing to pay an average of $9 for each potential connection service provided by
the network, will the firm profit by building the network?
(Click to select)

d. What is the increase in the number of potential connection services if one additional user joins the
network?
connection services

#5
A monopolist earns $40 million annually and will maintain that level of profit indefinitely, provided that
no other firm enters the market. However, if another firm enters the market, the monopolist will earn
$40 million in the current period and $10 million annually thereafter. The opportunity cost of funds is
20 percent, and profits in each period are realized at the beginning of each period.
a. What is the present value of the monopolists current and future earnings if entry occurs?
Instruction: Round your answer to the nearest two decimal places.
$

million

b. If the monopolist can earn $8 million indefinitely by limit pricing, should it do so?
(Click to select)