Question

4. Businesses are often accused of engaging in predatory pricing. However, competition regulators often have difficulties separating predatory pricing from vigorous competition. The Areeda–Turner test for predatory pricing states that if a firm sets its price above its marginal cost then it is probably not predatory pricing, but if it sets its price below marginal cost then it is probably predatory. Remembering our analysis of profit-maximising firms from chapters 14 and 15, explain why pricing below marginal cost might be viewed as a deliberate attempt to drive out a competitor rather than vigorous competitive pricing. Can you think of any situations where a firm might set a price below marginal cost but not be predatory pricing?

Answer 1

Predatory pricing policy is adopted by the producers to drive out the competitors in the markets. In this the producer charge a price which is below it cost. It is one of type of pricing. In this pricing policy in the initial stage price is charged below the cost of the product or ever free sometimes but when the competition reduces the producer charges high price. Due to the lack of competition producer enjoys the the market of monopoly sometimes. Jio the telecommunications company in India did the same in 2016. They distribute the Sim cards for free and provided the users free data but after they got established in the market the begin to charge the money.  On the other hand vigorous competition means a situation where there is very hard competition in the market and producers always in the race to nullify it.

The diagram shows the short run price determination under the monopolistic competition.

In the daigram on x-axis the output in shown and on y-axis the price is shown. AR is average revenue curve MR is marginal revenue curve AC is average cost curve and MC is marginal cost curve. The fare price for a producer will P were his profit will be CB but producer in the short run don't want profit he want to drive out the competitors from the market so he will charge price below P it may P1, P2, or in most of the cases it may be P3. This is known as predatory pricing policy. If the price is more than the AC then it is surely a fare price but when the price is less than the marginal cost then the price can surely be suggested as predatory price. On the other side when price is equal to the AC or just below the AC then it is vigorous pricing. There can be situations where the price which charged may be below than the marginal cost but it cannot be the case of predatory pricing like when good is sold as a discount with some other good then price charge is nill but the product holds some marginal cost.