Price Strategies

Idea

To pursue their objectives, firms deploy price strategies — deliberately setting price away from the profit-maximising level to shape entry, exit and market share. Each accepts lower profit now for a strategic gain later.

Mechanism

• Limit pricing — charging a price below the profit-maximising price, but low enough to sit under the estimated average cost of potential entrants. This raises an artificial barrier to entry: entrants who could not produce profitably at that price are deterred, so the incumbent sacrifices some short-run profit to protect its market share.

• Predatory pricing — charging a price below profit-maximising price (typically below marginal cost) temporarily, to force existing rivals out. Rivals must match the cut or lose share; those unable to sustain even normal profit in the long run exit, after which the aggressor enjoys greater market share and demand.

• Price war — unlike predatory pricing, which has a single aggressor, a price war is mutual: rival firms answer each other’s price cuts with further cuts, undercutting one another until one or more firms shut down and leave.

• Price rigidity — in an oligopoly, the tendency of price to stay constant. Because raising price loses share (rivals do not follow) and cutting price triggers matching cuts (so revenue falls anyway), firms have no incentive to move price in either direction.

Considerations

These strategies presuppose some price-setting power, so they are the conduct of imperfectly competitive firms — chiefly oligopolists and monopolists, not price-takers. Predatory pricing in particular is widely treated as anti-competitive and may be unlawful. Price discrimination is a further price strategy, distinct enough to warrant its own treatment.