The Economics of Predation: What Drives Pricing When There is Learning-by-Doing?
Northwestern University - Kellogg School of Management
Harvard University - Department of Economics; University of Pennsylvania - Business & Public Policy Department
Tepper School of Business, CMU
CEPR Discussion Paper No. DP8708
Predatory pricing -- a deliberate strategy of pricing aggressively in order to eliminate competitors -- is one of the more contentious areas of antitrust policy and its existence and efficacy are widely debated. The purpose of this paper is to formally characterize predatory pricing in a modern industry dynamics framework. We endogenize competitive advantage and industry structure through learning-by-doing.
We first show that predation-like behavior arises routinely in our model. Equilibria involving predation-like behavior typically coexist with equilibria involving much less aggressive pricing. To disentangle predatory pricing from mere competition for efficiency on a learning curve we next decompose the equilibrium pricing condition. Our decomposition provides us with a coherent and flexible way to develop alternative characterizations of a firms predatory pricing incentives, some of which are motivated by the existing literature while others are novel. We finally measure the impact of the predatory pricing incentives on industry structure, conduct, and performance. We show that forcing a firm to ignore these incentives in setting its price can have a large impact and that this impact stems from eliminating equilibria with predation-like behavior. Along with the predation-like behavior, however, a fair amount of competition for the market is eliminated. Overall, the distinction between predatory pricing and pricing aggressively to pursue efficiency is closely related to the distinction between the advantage-building and advantage-denying motives that our decomposition of the equilibrium pricing condition isolates and measures.
Number of Pages in PDF File: 44
Keywords: competition policy, industry dynamics, predatory pricing
JEL Classification: C73, L13, L44
Date posted: December 22, 2011