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  • P-ISSN 1738-656X
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한국개발연구. Vol. 13, No. 1, May 1991, pp. 151-166

https://doi.org/10.23895/kdijep.1991.13.1.151

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Dynamic Limit and Predatory Pricing Under Uncertainty (Written in Korean)

유윤하

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Abstract

In this paper, a simple game-theoretic entry deterrence model is developed that integrates both limit pricing and predatory pricing. While there have been extensive studies which have dealt with predation and limit pricing separately, no study so far has analyzed these closely related practices in a unified framework. Treating each practice as if it were an independent phenomenon is, of course, an analytical necessity to abstract from complex realities. However, welfare analysis based on such a model may give misleading policy implications. By analyzing limit and predatory pricing within a single framework, this paper attempts to shed some light on the effects of interactions between these two frequently cited tactics of entry deterrence. Another distinctive feature of the paper is that limit and predatory pricing emerge, in equilibrium, as rational, profit maximizing strategies in the model. Until recently, the only conclusion from formal analyses of predatory pricing was that predation is unlikely to take place if every economic agent is assumed to be rational. This conclusion rests upon the argument that predation is costly; that is, it inflicts more losses upon the predator than upon the rival producer, and, therefore, is unlikely to succeed in driving out the rival, who understands that the price cutting, if it ever takes place, must be temporary. Recently several attempts have been made to overcome this modelling difficulty by Kreps and Wilson, Milgram and Roberts, Benoit, Fudenberg and Tirole, and Roberts. With the exception of Roberts, however, these studies, though successful in preserving the rationality of players, still share one serious weakness in that they resort to ad hoc, external constraints in order to generate profit maximizing predation. The present paper uses a highly stylized model of Cournot duopoly and derives the equilibrium predatory strategy without invoking external constraints except the assumption of asymmetrically distributed information. The underlying intuition behind the model can be summarized as follows. Imagine a firm that is considering entry into a monopolist's market but is uncertain about the incumbent firm's cost structure. If the monopolist has low cost, the rival would rather not enter because it would be difficult to compete with an efficient, low-cost firm. If the monopolist has high costs, however, the rival will definitely enter the market because it can make positive profits. In this situation, if the incumbent firm unwittingly produces its monopoly output, the entrant can infer the nature of the monopolist's cost by observing the monopolist's price. Knowing this, the high cost monopolist increases its output level up to what would have been produced by a low cost firm in an effort to conceal its cost condition. This constitutes limit pricing. The same logic applies when there is a rival competitor in the market. Producing a high cost duopoly output is self-revealing and thus to be avoided. Therefore, the firm chooses to produce the low cost duopoly output, consequently inflicting losses to the entrant or rival producer, thus acting in a predatory manner. The policy implications of the analysis are rather mixed. Contrary to the widely accepted hypothesis that predation is, at best, a negative sum game, and thus, a strategy that is unlikely to be played from the outset, this paper concludes that predation can be real occurrence by showing that it can arise as an effective profit maximizing strategy. This conclusion alone may imply that the government can play a role in increasing the consumer welfare, say, by banning predation or limit pricing. However, the problem is that it is rather difficult to ascribe any welfare losses to these kinds of entry deterring practices. This difficulty arises from the fact that if the same practices have been adopted by a low cost firm, they could not be called entry-deterring. Moreover, the high cost incumbent in the model is doing exactly ...

JEL Code

L00

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