Predatory pricing is a pricing strategy used by an established firm to eliminate competition from equally efficient firms, and secure a monopoly position in a previously competitive market.
A firm practicing predatory pricing lowers its price below cost and maintains it there until equally efficient competitors are forced to incur unsustainable losses and exit the market. The firm then raises its price to a monopoly level in order to recoup its lost profits.
Predatory pricing is a risky strategy. The firm involved incurs high up-front losses, with no guarantee of future gains from monopolization. The strategy will only be profitable if, once all competitors have been forced out of the market, the incumbent is able to raise its prices to a monopoly level and keep them there. If the firm is subject to either direct price regulation or some other form of control, predatory pricing is unlikely to succeed.
Predatory pricing requires high barriers to entry. If firms are able to enter the market easily, then each time the incumbent increases its price this will attract new entrants into the market, forcing the incumbent to drop its price again.
A less aggressive type of exclusionary pricing is limit pricing. Limit pricing occurs when a firm with low costs sets prices above its own costs, but below a potential competitor's costs. This can discourage new firms from entering the market, but may not force existing competitors out of the market.
For it to succeed, limit pricing may require tacit collusion from all or most existing firms. Existing firms must be willing to reduce the market price below profit maximizing levels, to the point that any higher cost entrants have no prospect of making a profit.
Limit pricing may only discourage entry by less efficient firms. So even though limit pricing may deter new entry, it does not necessarily hurt customers or reduce social welfare.
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