Baker decided not to pursue limit pricing as described in the previous problem. Now they find themselves with a competitor, which limits their profit to $4 million per year. However, if Baker drops its price to $68 per chip and holds it there for one year, it will be able to drive the other firm out of the market and regain its market power (earnings $10 million per year in profit as described in the previous problem). Over the year in which it engages in predatory pricing, however, Baker will lose $60 million.
a. Ignoring legal considerations, is predatory pricing a profitable strategy? Assume the interest rate is 10 percent and, for simplicity, that any current period profits or loses occur immediately (at the beginning of the year).
b. What if the interest rate were 5 percent instead of 10?