Question

What is the basic difference between limit pricing and predatory pricing? Under the Areeda-Turner guidelines, when would predatory pricing be prosecuted?

Answer 1

Solution

Predatory Pricing : It is the strategy followed by the firms in which the goods/services are intentionally sold at a very low price (even below average variable cost) inorder to kill competition (i.e.,drive the competitors out of the market).

This method is followed by large congolmerates which have deep pockets.So in this process,the financially weaker firms who are not able to withstand the losses are forced to shut down and exit.So ultimately,there would not be competition also because new entrants will not be there looking at the losses the whole industry is making.

Then the firm increases the price to the normal / high levels and recovers all the losses it incurred previously and thus becomes profitable.

Example:Wallmart's pricing strategy is a classic example of Predatory pricing.

Limit Pricing : In this strategy the existing players maintain the prices in such a way that it becomes difficult for the new entrants to enter the industry.The price is little high when compared to the case of predatory pricing.

Here the price is set below short-run profit maximization level but above the competition level.

Example (fictional) : Say the demand for oil is stable.The OECD is a cartel having the majority market share.Suppose Russia plans to increase its maket share in oil production,the OECD will counter that by decreasing it's selling price of the oil.It will set the price at which Russia will be not be able to prioduce oil profitably.Inthis eventhough the profits of OECD will reduce but they will not incur loss.So ultiately they try to maintain their market share by using this pricing strategy.

According to Areeda-Turner guidelines,a price is called predatory only when it is lower than the anticipated short-run marginal cost.Then the firm following predatory pricing is prosecuted.

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