The Concepts of Limit and Predatory Pricing - 1927 Words

Discuss the concepts of limit and predatory pricing. Explain how imperfect knowledge of other firms’ costs or financial conditions can lead to limit or predatory pricing. Limit pricing is when an incumbent firm sets a â€Å"low price with the purpose of deterring entry†. Predatory pricing is when an incumbent sets an â€Å"‘irrationally’ low price [possibly below cost] so other firms can’t compete† forcing existing firms to exit the market. Both pricing strategies require at least two periods: the first to deter entry/force exit of a rival; the second to reap the benefits of lower competition. Although both are examples of illegal anti-competitive behaviour, only the latter is usually pursued with litigation. In order to engage in limit pricing, an†¦show more content†¦In the first period Indep sets the price. Pevin observes this, then decides whether to enter in the second period. Indep knows its own cost function, but Pevin does not know Indep’s. Furthermore, both firms know this. Although Pevin does not know whether Indep has a high or low unit cost, it does know the probability that Indep is a high-cost (inefficient) and low-cost (efficient) type. In the first period there are three possible scenarios: * Indep is efficient and sets a low monopoly price – earning  £100m * Indep is inefficient and sets a high monopoly price – earning  £60m * Indep is inefficient and sets a low monopoly price – earning  £40m In the second period, if Pevin abstains from entry, Indep sets the optimal price for its type earning  £100m (efficient) or  £60m (inefficient). Pevin earns zero profit. But, if Pevin enters, Indep earns  £50m (efficient) or  £20m (inefficient). Moreover, Pevin earns  £20m if Indep is inefficient and loses  £20m if Indep is efficient. Although it may seem irrational for an inefficient Indep to set a low first period price, it may do so to influence Pevin’s entry strategy. For, if Pevin believes that Indep’s low price is an indication of low-cost type and abstains from entry, then Indep earns  £100m overall ( £40m period 1 +  £60m period 2). This is higher than the  £80m ( £60m period 1 +  £20m period 2) it would earn if it set a high price in both periods. Similarly, ifShow MoreRelatedEconomic Analysis of an Oligopoly Market Structure1715 Words   |  7 Pagesas they encourage competitive pricing, albeit predatory pricing, it is clear that Woolworths and Coles control the supermarket industry in Australia, in the formation of a duopoly. It is evident that Woolworths and Coles engage in predatory pricing in an attempt to eliminate independent retailers from the market. 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