A new hotel company (the entrant) is planning on building a new hotel next year adjacent to an incumbent hotel company which, to date, has had a monopoly on the hotel market, earning $100 million in profit a year. The incumbent has indicated that in the event of entry, it will engage in aggressive competition by cutting its room rates in half. Doing so would result in the incumbent earning a profit of $45 million but the new firm would lose $15 million. If the incumbent did not change its price, each would earn $50 million in profit. Predict what will happen.

 

• Suppose the incumbent plans to invest $5 million in additional hotel capacity before the entrant begins building its hotel. Predict what will happen.

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 Consider the previous two questions. Suppose the incumbent plans to invest $5 million in additional capacity AND an additional $5 million in advertising to announce the capacity addition before the entrant begins building. Predict what will happen. 

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