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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