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The profits of an incumbent monopolist, currently 2 0 m , are threatened by a potential entrant. If there is entry, and the incumbent and
The profits of an incumbent monopolist, currently are threatened by a potential entrant. If
there is entry, and the incumbent and entrant decide to share the market, the incumbent will earn
profits of and the entrant will earn However, if there is entry, and the incumbent and
entrant decide to engage in a price war, the incumbent will earn profits of and the entrant will
earn Prior to entry, the incumbent can invest in extra productive capacity to improve its
competitive position in the event there is entry and a price war. The cost is but it will raise the
incumbent's profits in a price war by to before the investment cost is deducted, and
lower the entrant's profits to a loss of Assume that the potential entrant earns zero profits if it
decides not to enter and that the incumbent's decision to invest is visible to the potential entrant.
a What are the equilibrium strategies of the incumbent and potential entrant if the investment
cost is sunk? Comment on the welfare implications to society of your solution.
marks
b What are the equilibrium strategies of the incumbent and potential entrant if the investment
cost is not sunk?
marks
c Critically discuss the role sunk costs play in business strategy.
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