The Economics of Predatory Pricing
Introduction
Predatory pricing “is alleged to occur when a firm sets a price for its product that is below some measure of cost and forfeits revenues in the short run to put competitors out of business” (Sheffet p.163-164). The reason firms take the short term loss is because they hope to drive out competitors and raise prices to monopolistic levels. By doing this, they covered their short term loss to make even greater profits in the long term than they would have by not using predatory tactics (Sheffert). Predatory pricing became illegal under Section 2 of the Sherman Act. It has remained one of the more difficult allegations for prosecutors to prove, due to the complexity of determining the company’s actual intent and whether or not it the strategy is competitive pricing. According to Areeda and Turner, there are three ways to determine if a firm is implementing predatory pricing. First, a price above marginal cost is presumed lawful; second, a price below marginal cost is considered unlawful, except when there is strong demand; and third, average variable cost is considered a good proxy for marginal cost. This is a reason predatory pricing is still important today. The courts must decide whether or not companies are engaging in competitive prices for the good of the consumers or are using predatory tactics for the good of their own company. The purpose of this paper is to focus on the current legislation regarding predatory pricing, determining when there is predation in an industry and the cause and effect relationship it has on an industry.
The Current View and Legislation on Predatory Pricing
When people think of predatory pricing, two main laws come to the minds of most...
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Tommy Takem owns a small appliance store in the southwest part of the state of Virginia. Tommy has built his business on targeting the poor, unsophisticated, and uneducated in the Appalachian regions of Virginia, Kentucky, Tennessee, and West Virginia. There is little competition in the region where he sells his goods; therefore, he charges 10-20% higher prices than the nearest retail competition. Furthermore, as a ruse to increase sales, Takem’s has hired a few high pressure salespeople to go door-to-door selling the appliances and electronics at a markup of 30% more than his retail location, though this information is not disclosed to the purchaser. Also, as most of Tommy’s clientele have poor credit, the financing is handled by Takem’s Appliances as well, with an additional charge of 15% plus the highest interest rate allowable by
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Price discrimination can be defines as when a firm offers an “individual good at different prices to different consumers” The Library of Economics and Liberty elaborates on its pricing strategy, stating Comcast offers different pricing depending on what features the consumer desires. For instance, the cable company will charge a higher price to a person who uses several services as part of their cable package. Conversely, the firm charges a very low price to someone who would “otherwise not be interested” , providing basic services at a minimum price. It takes advantage of the regulation imposed on the cable industry by offering the required basic package at seemingly attractive prices. Using this pricing system allows for it to attract different consumers whose maximum price they are willing to pay differs. Recently, Comcast attempted a new billing strategy by introducing a data usage cap. It essentially expanded on the company’s existing price discrimination method by charging customers according to how much data they used each month. Comcast also utilizes penetration pricing, where it offers its product at low prices to attract new consumers, later raising the prices once the customer is subscribed for a certain amount of time. Generally it claims the original prices were promotional only, lasting only a small amount of
Apart from Antitrust laws, there are several other laws that promote fair business practices. The Robinson-Patman Act prohibits price discrimination. This act ...
Many businesses used this new process to raise the price of their competitors. They did this by putting constraints on entry restrictions (Woods 1986). At the state level, other laws were put in place to support the Food and Drug Act mainly to help local and area producers who were and would be facing new nat...
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Antitrust laws are a collection of federal and state laws that regulate the business practices of large companies in order to promote and protect fair competition within an open-market economy. These laws prevent businesses from taking part in unfair business activities such as, but not limited to, price fixing, market allocation, and bid rigging. Price fixing is when two or more competitors agree to each charge the same price for a product and not undercut each other. Market allocation is when competitors agree to divide markets among themselves, you stay out of my territory and I’ll stay out of yours. Bid rigging is when several businesses within a market agree to take turns winning and losing bids in order to maintain market control and prevent competition. As you can imagine, these unlawful business
Predatory pricing is the practice of selling products or services at quite low prices, in order to drive the competition out of the market, or to hinder the entry of the potential competitors. This involves pricing a product low enough in order to dampen demand. This pricing is generally used to end competitive threats. The company lowers the price with an aim of protecting market share from moving to the hands of the competitors. At times firms may reduce prices to sell off their outdated stock or to fill gap with their new line of products. Some vendors tend to set very low prices for new products while introducing them in the market with a view to inspire customers to try them out. However, this legal and ethical pricing strategy becomes illegal when a company uses unethical price cuts in order to squash the sales of its competitors by selling the same product at a lower price. Federal laws are made to protect the competitors from
As one commentator has explained, the Robinson-Patman Act “was designed to protect small businesses from larger, more efficient businesses. A necessary result is higher consumer prices.” Moreover, the Act ironically appears increasingly to be ineffective even in protecting small businesses. Over time, many businesses have found ways to comply with the Act by, for example, differentiating products, so they can sell somewhat different products to different purchasers at different prices. Such methods are likely to increase the seller’s costs—and thus increase costs to consumers—but do nothing to protect small businesses. The Act generally appears to have failed in achieving its main
Investigating a foreign firm of alleged price dumping can be very complex, this is due to many factors to consider, such as, whether the products have the same characteristics or whether they are made in the same “like product” or equal value. This mean, if the Commerce Department does not have the identical product to compare it to, they will utilize another product that has closed resemble to the original product, which could result in a subjective conclusion. In the case of Pesquera Mares Australes Ltda. v. United States 266 F.3d 1372 (2001), demonstrates how Commerce Department could lead to a complicated matter in determining what the “like product” entails (Schaffer, Agusti, & Dhooge, 2015, p. 299-300).
To become successful in business it is essential to have a dog eat dog mentality as your competition may attempt to work the legal systems to gain a competitive advantage against you. That is exactly how Shell describes legislation, regulation, and litigation uses as an advantage for firms in his book titled Make the Rules or Your Rivals Will. The first example, network TV companies (Fox, CBS and ABC) vs. satellite TV companies (DirecTV, Dish Network, and PrimeTime 24), demonstrates how the customer plays a key part in the way legislation is shaped to benefit both parties. The second example, RCA vs. CBS, demonstrates how they used regulation to set the color TV standard in the 1950’s in an effort to force the markets to use their products. The third and last
Price discrimination is part of the legal business strategy. It is occurring when companies charge different prices of the same goods and services to each customer or each type of customers to maximise profit based on the consumer 's price sensitivity and willingness to pay. It is not based on the cost of production, and it exists because different users place different values or prices on the same products. Therefore, companies can classify their customers based on the common traits and group them together to charge different prices. Firms are maximizing the producer surplus and changing the consumer surplus into supernormal profit. Consumer surplus is the difference between the maximum prices that the buyers willing to pay and the price they actually pay. Producer surplus is the difference between the minimum
Price discrimination is a pricing strategy that charges customers different prices for the same product or service. In pure price discrimination, the business charges a customer the maximum price that they are willing to pay. This practice is becoming more and more important for customers because of the discrete ways that businesses are finding to make it easier to implement them in many different ways. These are categorized into three forms: first-degree price discrimination, second-degree price discrimination and third-degree price discrimination. First degree price discrimination is where consumers pay the exact price that they are prepared to pay, and where the producer charges different prices depending on how much the consumer is looking to pay.