Suppose the incumbents price goes down with entry is that predation Could just

# Suppose the incumbents price goes down with entry is

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Suppose the incumbent’s price goes down with entry: is that predation? Could just be that duopoly price < monopoly price Suppose, further, that incumbent’s price is lower than its marginal cost : is that predation? Could be a loss leader (e.g. milk at the supermarket) Or a complementary good (e.g. Kodak and cameras, Disney and cruises) Or learning by doing
Predation So how do you ever conclusively detect predatory pricing? A smoking gun helps There are lots of predatory pricing cases. 90% are lost. Simple explanation: High prices lure overoptimistic entrants Entry induces price competition Entrant leaves Complains to regulator 12
13 The Chicago critique Predatory pricing hurts the predator at least as much as it hurts the prey So in equilibrium the incumbent won’t even attempt to predate. Let’s formalize this by adding an “exit option” to our game from before.
14 Adding an exit option “Exit option”: we add another stage to the game where the entrant may choose to exit the market Suppose as before that monopoly profit is \$400, duopoly profit is \$100 each, and profit in a price war is \$-100 each Suppose there are now two post-entry stages Starbucks chooses to price High or Low & this determines stage 1 profits Intelligentsia decides whether to Quit or Stay If Intelligentsia quits Starbucks earns monopoly profits in stage 2 If Intelligentsia doesn’t quit then the two firms price High going forward. Both earn duopoly profits in stage 2
15 Adding an exit option p low p high Starbucks ( \$-100 ,\$-100 ) + ( \$100 ,\$100 ) = ( \$0 ,\$0 ) stay quit stay quit ( \$100 ,\$100 ) + ( \$100 ,\$100 ) = ( \$200 ,\$200 ) ( \$100 ,\$100 ) + ( \$0 ,\$400 ) = ( \$100 ,\$500 ) enter Intelligentsia Stage 1 + Stage 2 = Total ( \$-100 ,\$-100 ) + ( \$0 ,\$400 ) = ( \$-100 , \$300 )
16 The Chicago Critique Equilibrium Intelligentsia would never choose to exit because it always prefers duopoly profits in stage 2 (\$100) to the profits it gets if it quits (\$0) Knowing this, Starbucks will always choose to price high in stage 1 Knowing this, Intelligentsia will always choose to enter in stage 0 Adding the possibility for Entrant to exit doesn’t provide any incentive for Incumbent to fight Why? The entrant’s losses from the fight are sunk: don’t affect decisions in subsequent period This is the heart of the “Chicago Critique” of predation
Critiques of the Chicago Critique I just argued that the Incumbent will not engage in predatory pricing Anyone want to criticize my argument? 17
Critiques of the Chicago Critique I just argued that the Incumbent will not engage in predatory pricing Anyone want to criticize my argument? Two main critiques: Financial market imperfections Signaling stories 18
19 Financing constraints For predation to drive an entrant out of the market, entrant must have a financing constraint such that it can’t sustain low profits for a prolonged period Consider a bank’s position See entrant has low profits See incumbent behaving aggressively Would you lend the entrant money?

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