Chapter 9: Problem 11

What is predatory pricing?

Short Answer

Expert verified

Predatory pricing is an anti-competitive strategy where a dominant company lowers the price of a product or service to drive competitors out of the market or prevent them from entering. The intent is to create barriers to entry and exploit market power. Competitors may downsize, reduce production, or exit the market, while new entrants are discouraged from entering. Once competition is eliminated, the predatory company raises prices, leading to higher costs for consumers and limited choices. Predatory pricing is often considered illegal or unethical, and many countries have laws and regulations to penalize such practices.

Step by step solution

Defining Predatory Pricing

Predatory pricing is an anti-competitive strategy where a dominant company (or a company with significant financial resources) lowers the price of a product or service to drive competitors out of the market or prevent them from entering the market. This temporary loss of profit is considered an investment in the long run, as the company hopes to recoup these losses by raising prices once competition is eliminated.

Understanding the Intent of Predatory Pricing

The primary intent of predatory pricing is to create barriers to entry and exploit market power. By setting prices lower than competitors can afford, the company with predatory pricing aims to eliminate competitors or force them to reduce their production levels, eventually leading to a monopoly or highly concentrated market.

Identifying the Effects on Competitors

The competitors of the company practicing predatory pricing face several challenges. As they struggle to match the lowered prices, they may be forced to downsize, reduce production or product quality, or exit the market altogether. New entrants may be discouraged from entering the industry, as they cannot compete with the low prices while maintaining profitability.

Evaluating the Long-term Consequences

Once the company has successfully driven its competitors out of the market, it may begin to raise its prices back to their original level or even higher to recoup the lost profits. In the long run, this leads to higher prices for consumers and less choice in the market, which is a result of the monopoly or market power that the predatory company now has.

Legal and Regulatory Implications

Predatory pricing is often considered an illegal or unethical business practice, as it is intentionally harmful to competition and consumer welfare. Many countries have laws and regulations in place to penalize companies that engage in predatory pricing, with the goal of maintaining a competitive and healthy marketplace.