Predatory pricing

Definition

Predatory pricing is a pricing strategy where a firm sets its prices extremely low with the intention of driving competitors out of the market or preventing new entrants. This tactic can be particularly effective in monopolistic situations, where a single firm dominates the market and can sustain short-term losses to eliminate competition. In markets with barriers to entry, predatory pricing becomes a powerful tool for maintaining monopoly power by discouraging potential entrants from even attempting to compete.

5 Must Know Facts For Your Next Test

1. Predatory pricing is often considered anti-competitive because it can lead to monopolization of a market, reducing choices for consumers in the long run.
2. Firms engaging in predatory pricing typically have the financial resources to sustain losses for a longer period than their competitors.
3. This strategy can lead to legal consequences as many jurisdictions have laws against anti-competitive practices.
4. Predatory pricing is most effective in markets with high fixed costs and low marginal costs, making it easier for incumbents to sustain lower prices.
5. In contestable markets, the threat of predatory pricing can deter new entrants even if prices appear low, as potential competitors fear being driven out.

Review Questions

• How does predatory pricing relate to the characteristics of monopoly, particularly in terms of market control and consumer choice?
  • Predatory pricing is closely tied to monopolistic characteristics because it allows a dominant firm to leverage its market power by setting prices low enough to push competitors out. In a monopoly, the firm can sustain these low prices longer than smaller competitors who lack the same financial resources. This behavior reduces consumer choice as competitors exit the market and ultimately leads to higher prices once competition is eliminated.
• Discuss the role of barriers to entry in facilitating predatory pricing strategies by established firms.
  • Barriers to entry are critical in enabling established firms to engage in predatory pricing successfully. When significant barriers exist, new entrants face challenges that limit their ability to compete effectively. Established firms can lower prices without fear of immediate competition entering the market, as potential new entrants might be discouraged by the prospect of facing sustained low prices designed to drive them out. This creates a cycle where existing firms maintain their monopoly by using predatory pricing as a deterrent.
• Evaluate the long-term implications of predatory pricing on market dynamics and consumer welfare in both monopolistic and contestable markets.
  • The long-term implications of predatory pricing are significant for both monopolistic and contestable markets. In monopolistic settings, once competition is eliminated through sustained low pricing, firms can raise prices and reduce output, harming consumer welfare. In contestable markets, even the threat of predatory pricing can deter new entrants, limiting innovation and variety for consumers. Ultimately, while initial low prices may benefit consumers temporarily, the reduction of competition leads to negative outcomes such as higher prices and less choice over time.

Related terms

Monopoly: A market structure where a single seller controls the entire supply of a product or service, often leading to higher prices and reduced consumer choice.

Barriers to entry: Obstacles that make it difficult for new competitors to enter a market, which can include high startup costs, legal restrictions, or strong brand loyalty.

Price war: A competitive situation where businesses lower prices in an aggressive manner to gain market share, often leading to reduced profits for all players involved.