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In the Milgrom and Roberts, if Newvel enters and competes against an inefficient incumbent, it earns a positive profit of $20 million. But if the incumbent turns out to be a low cost type, then entry results in a loss of $20 million for Newvel. Assume that the probability that the incumbent is a high-cost firm is 50%, then Newvel’s expected profit from entering is:Select one:a.-1,5.b.1.c.1,5.d.-1.e.0.

Question

In the Milgrom and Roberts, if Newvel enters and competes against an inefficient incumbent, it earns a positive profit of 20million.Butiftheincumbentturnsouttobealowcosttype,thenentryresultsinalossof20 million. But if the incumbent turns out to be a low cost type, then entry results in a loss of 20 million for Newvel. Assume that the probability that the incumbent is a high-cost firm is 50%, then Newvel’s expected profit from entering is:Select one:a.-1,5.b.1.c.1,5.d.-1.e.0.

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Solution

To calculate the expected profit, we need to multiply each outcome by its probability and then sum these results.

  1. If Newvel competes against an inefficient incumbent (high-cost firm), it earns a profit of 20million.Theprobabilityofthishappeningis5020 million. The probability of this happening is 50%, or 0.5. So, the expected profit from this outcome is 0.5 * 20 million = $10 million.

  2. If Newvel competes against a low-cost incumbent, it incurs a loss of 20million.Theprobabilityofthishappeningisalso5020 million. The probability of this happening is also 50%, or 0.5. So, the expected loss from this outcome is 0.5 * -20 million = -$10 million.

Adding these two expected values together gives us the total expected profit for Newvel:

10million−10 million - 10 million = $0 million

So, the answer is e. 0.

This problem has been solved

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