Microsoft has a virtual monopoly in the market for personal computer operating systems and business software. But there is a constant threat that another firm will launch competing products, so Microsoft engages in limit pricing to deter entry into its key markets. A recent study revealed some of the numbers behind the insecure monopoly.

1. The pure monopoly price for a software bundle of the Windows operating system and the Office Suite of business tools is about $354, but the actual price (the limit price) is about $143. The estimated cost for a second firm to develop, maintain, and market an alternative software bundle is about $38 billion, and Microsoft’s actual price is just low enough to make such an investment unprofitable.

2. The pure monopoly profit would be about $191 billion, while the profit under Microsoft’s limit pricing is about $153 billion. Although the profit under the entry-deterrence strategy is less than the pure monopoly profit, it is greater than the profit Microsoft would earn if it allowed a second firm to enter the market ($148 billion). In other words, entry deterrence is the best strategy.

Question.

How does a monopolist respond to the threat of entry?