Microsoft charges a price of \$599 for a copy of Windows 7. According to the principle that people respond to incentives, is this pricing decision rational from the perspective of Microsoft?

• A. Yes, because higher prices always lead to higher profits regardless of demand.
• B. No, because rational firms should always set the lowest possible price.
• C. No, because any price above \$100 is always irrational for software products.
• D. Yes, if Microsoft believes that this price maximizes its profit given consumer demand and production costs.

Answer: (D)

Verified step by step guidance

1. Understand the principle that people respond to incentives, which means firms set prices to influence consumer behavior and maximize profits.
2. Recognize that a rational firm sets a price where its profit is maximized, which depends on both the price charged and the quantity demanded at that price.
3. Recall that profit is calculated as total revenue minus total cost, where total revenue is price multiplied by quantity sold: \(\text{Profit} = (P \times Q) - \text{Cost}\).
4. Consider that setting a higher price does not always increase profit because it may reduce quantity demanded; similarly, setting a very low price may increase sales but reduce profit margins.
5. Conclude that Microsoft's pricing decision is rational if it believes that charging \$599 maximizes its profit given the demand for Windows 7 and the costs of producing and distributing the software.