Assume two firms are currently competing in a market. If one of the tw

Assume two firms are currently competing in a market. If one of the two firms wants to try to eliminate the other firm as a competitor, should it undertake a strategy of limit pricing or predatory pricing? Why? In addition, describe the conditions

under which the strategy you have selected will be most successful.

ANSWER

The firm should adopt a strategy of predatory pricing. While it is true that both pricing strategies are intended to limit the amount of competition the firm practicing such strategies will face from other firms, limit pricing is used primarily to discourage entry by other firms. This is accomplished by setting price at a level that would force the potential entrant to incur a loss, while still affording the existing firm either zero or positive economic profit. In contrast, predatory pricing occurs when an existing firm sets price below its average total costs (and presumably those of its rivals) in order to force competitors out of the market. For this strategy to be most successful, the firm must be able to make a credible commitment to sticking with it for as long as it takes for the strategy to be effective. In addition, it must be unlikely for new competitors to enter the market once the strategy ceases and the period of time needed to recoup losses must be relatively short.