Predatory Pricing

Definition

Predatory pricing is a strategy where a company sets its prices extremely low, often below cost, to drive competitors out of the market or deter new entrants. This practice can lead to short-term financial losses for the predator but aims to establish long-term market dominance by eliminating competition. It connects to strategic behavior in oligopolistic markets, where firms must carefully consider their pricing strategies in relation to their rivals.

5 Must Know Facts For Your Next Test

1. Predatory pricing is illegal in many jurisdictions, as it can lead to monopolistic practices that harm consumers and the market.
2. Companies engaging in predatory pricing may temporarily lower prices to unsustainable levels, hoping that rivals will exit the market and they can raise prices afterward.
3. This strategy is often used in industries with high fixed costs and low marginal costs, making it easier for firms to absorb losses.
4. While predatory pricing can be an effective tool for market control, it requires careful legal navigation to avoid antitrust lawsuits.
5. Successful predatory pricing can result in a firm gaining significant market share and potentially leading to higher prices once competition is reduced.

Review Questions

• How does predatory pricing affect competition in an oligopoly, and what strategic decisions do firms need to make regarding this practice?
  • In an oligopoly, predatory pricing can significantly alter the competitive landscape by driving weaker competitors out of the market or preventing new entrants. Firms must weigh the risks of financial losses against potential long-term gains from reduced competition. They also need to consider legal implications, as predatory pricing may attract scrutiny from regulatory bodies that enforce antitrust laws.
• Discuss the relationship between predatory pricing and barriers to entry in an oligopolistic market. How does this practice influence potential competitors?
  • Predatory pricing can create significant barriers to entry for potential competitors in an oligopolistic market. By setting prices at unsustainable levels, established firms can deter new entrants who may not have the resources to compete at such low prices. This tactic not only reinforces the dominance of existing firms but also limits consumer choice and innovation in the long run.
• Evaluate the ethical implications of predatory pricing in relation to market fairness and consumer welfare. What are the broader economic consequences?
  • The ethical implications of predatory pricing are significant, as this practice can undermine market fairness and consumer welfare. By using aggressive pricing strategies to eliminate competition, firms may ultimately create monopolistic conditions that lead to higher prices and fewer choices for consumers once rivals are driven out. The broader economic consequences include reduced innovation, increased market concentration, and potential regulatory backlash aimed at restoring competitive balance.

Related terms

Oligopoly:

A market structure characterized by a small number of firms that dominate the market, leading to interdependent decision-making.

Market Share: The portion of a market controlled by a particular company or product, often influenced by pricing strategies and competition.

Barriers to Entry: Obstacles that prevent new competitors from easily entering an industry or area of business, which can be influenced by predatory pricing.