Differing Objectives and Policies of Firms – Predatory Pricing
What is Predatory Pricing?
Predatory pricing is when a firm sets its price below its own costs in order to drive competitors out of the market. Once rivals have left, the firm can raise prices again to earn higher profits. Think of it as a bully at school who offers to pay less for a snack just to make the other stalls shut down, then later charges a lot more when they’re the only ones left. 📉➡️📈
Why Do Firms Do It?
- To eliminate competition and become the sole supplier.
- To increase market power and raise prices later.
- To drive out new entrants who might threaten future profits.
- To gain economies of scale by expanding production after rivals exit.
Key Conditions for Predatory Pricing
- Low costs – the firm must be able to sustain losses for a while.
- High barriers to entry – new firms cannot easily replace the predator.
- Market power – the predator must have enough sales to affect rivals.
- Ability to re‑price after competitors exit.
Mathematical Illustration
Let the predator’s cost be \$C\$, and the price it sets be \$P_t\$.
If \$Pt < C\$, the predator incurs a loss of \$C - Pt\$ per unit.
The predator will continue until the total loss \$L = (C - P_t) \times Q\$ is acceptable, where \$Q\$ is the quantity sold during the predatory period.
After rivals exit, the predator can raise the price to \$Pf > C\$ and earn a profit of \$Pf - C\$ per unit.
Real‑World Example: Supermarket Wars
A large supermarket chain might lower the price of a popular cereal to £1.00 (below its cost of £1.20) to force a small local shop to close. Once the shop is gone, the supermarket raises the price to £1.50, earning higher profits. This is a classic case of predatory pricing. 🛒💰
Legal and Regulatory View
- UK: Competition Act 1998 – predatory pricing is prohibited if it is likely to eliminate competition.
- EU: Article 102 TFEU – abuse of dominant position, including predatory pricing.
- US: Sherman Act – similar provisions against price cuts that harm competition.
Case Study: The "Big Box" vs. "Local Boutique"
| Firm | Strategy | Outcome |
|---|
| Big Box Retailer | Prices down to £0.90 (cost £1.00) for 6 months. | Local boutique closes. |
| Big Box Retailer | Raises price to £1.30. | Higher profits, no competition. |
Key Takeaways for Students
- Predatory pricing is a strategic move to dominate a market.
- It requires short‑term losses for long‑term gains.
- Regulators monitor such behaviour to protect consumer welfare.
- Remember the bully analogy – it helps you visualise the process.
- Use the mathematical model to calculate potential losses and profits.
Quick Quiz
- What is the main objective of a firm engaging in predatory pricing? (Answer: To eliminate competition and later raise prices.)
- Which law in the UK prohibits predatory pricing? (Answer: Competition Act 1998.)
- Why is it risky for a firm to set prices below cost? (Answer: It incurs losses that must be sustainable.)