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

Answer: (A)

Verified step by step guidance

1. Understand the principle that people respond to incentives, which means firms set prices to maximize their objectives, typically profit.
2. Recognize that a firm's pricing decision is rational if it maximizes profit, which depends on both the price charged and the quantity demanded at that price.
3. Recall that profit maximization occurs where marginal revenue equals marginal cost, not necessarily at the lowest or highest price possible.
4. Evaluate that setting a price of \$599 can be rational if Microsoft believes this price balances consumer demand and production costs to yield the highest profit.
5. Conclude that the rationality of the price depends on Microsoft's expectations about demand and costs, not on arbitrary price levels or assumptions about always lowering prices.