Sanford Inc. currently competes in a duopoly. The market price is $10 and Sanford's annual profit is $10 million. If Sanford were the only firm in the market, it could charge the monopoly price of $25 per unit and earn $35 million annually for an indefinite period of time. By charging $5 per unit for one year, Sanford could drive its rival out of the market and maintain a monopoly position indefinitely. However, this strategy will result in a $20 million loss since its marginal cost is $8 per unit.
a. What pricing strategy is the manager considering?
b. Ignoring legal considerations, is this pricing strategy profitable? Assume the interest rate is 5 percent and, for simplicity, that any current period profits or losses occur immediately (at the beginning of the year)
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