Consider the following information regarding a monopolist
Price = $20 / unit
Sales = 200,000 units...

Question

Consider the following information regarding a monopolist 
Price = $20 / unit 
Sales = 200,000 units 
Fixed Costs = $1000000 
Variable Costs = $5 / unit 
The monopolist uses a ten year planning horizon and a discount rate of 7%. 
If a new firm enters the market today, the monopolist will have to permanently reduce the price to $16/unit to retain its sales. The monopolist believes that the new entry can be prevented if the price were reduced to $12/unit immediately and for the next three years (0-3), after which the price can be brought back to the original level for the remaining years XXXXXXXXXXThis price reduction would also increase sales to 220,000 units during the relevant years. 
a) Make the decision tree. 
b) What is the optimal strategy for the monopolist?

David · Accepted Answer

Consider the following information regarding a monopolist Price = $20 / unit Sales = 
200,000 units Fixed Costs = $1000000 Variable Costs = $5 / unit The monopolist uses a ten 
year planning horizon and a discount rate of 7%. If a new firm enters the market today, the 
monopolist will have to permanently reduce the price to $16/unit to retain its sales. The 
monopolist believes that the new entry can be prevented if the price were reduced to 
$12/unit immediately and for the next three years (0-3), after which the price can be 
brought back to the original level for the remaining years##########This price 
reduction would also increase sales to 220,000 units during the relevant years. a) Make the 
decision tree. b) What is the optimal strategy for the monopolist?
Answer: 
[Suppose monopolist realized the profit only at the end of year] 
Total cost = fixed cost + variable cost = 1000000+5x,

Consider the following information regarding a monopolist Price = $20 / unit Sales = 200,000 units Fixed Costs = $1000000 Variable Costs = $5 / unit The monopolist uses a ten year planning horizon and...

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