Question

With limit pricing, the incumbent charges a price that is ______ the monopoly price and at the limit price the entrant has _________.

a. below, zero accounting profit

b. below, some sales but less than the encumbent

c. below, zero economic profit

d. above, zero economic profit

e. none of the above

Answer 1

With limit pricing, the incumbent charges a price that is ______ the monopoly price and at the limit price the entrant has _________.

ANSWER IS OPTION  'C'

a. below, zero accounting profit - This won't be the correct answer because accounting profit would not affect the decision of new firms entering the market because it does not include implicit costs of producing and also, it just accounts for the monetary profit in the short run.

b. below, some sales but less than the encumbent - This is not possible because if the price is set below monopoly price level, the entrant would be in loss and not able to make any profit at all.

c. below, zero economic profit - This would be the correct answer because a firm would always take into account its economic profit before entering or exiting a market. A firm's economic profit would account all its total revenue (including monetary and opportunity cost) less its total cost. It is the long term profit that the firms enjoy. In this case, the incumbent will charge a price below the monopoly price and the entrant will have zero economic profit which will make it unsuitable for entry.

d. above, zero economic profit - This is not possible, because in order to restrict entry of new firms, the incumbent has to charge prices lower than the monopoly price so that, they earn enough profit than the competitive market but also make it unsuitable for new entrant.

Definition of Limit Pricing - It is a pricing strategy adopted by the monopolist to make sure that no new firms can enter the market to ensure its abosolute monopoly power. It can do so by reducing the level of price, so that the new entrant has no incentive to join the market.