Entry/Exit .5 (Predation)

Question 1

What is Predation?

Answer 1

Pricing/ non-pricing behaviour that restricts competition by driving out existing rivals/ excluding potential ones

Sacrificial phase followed by recoupment phase

Question 2

How is predation tested? (3 ways)

What are problems associated with each?

…what are type I and type II errors in assessing predation?

Answer 2

• [‘p < S-R MC’ = predation]
  ^MC = difficult to estimate
  ^predators may sacrifice profit with p still above MC
• [‘p vs L-R MC’, ‘Intent to exclude equally/ more efficient competitor’]

-[‘output expansion after entry’, ‘p vs AVC’]
^ “New E may cause I’s residual demand to fall -> lowers their price without predatory intent” -> Ho

Type I - reject Ho, when Ho is true (suspect predation when no predation occurs)
Type II - fail to reject Ho, when Ho is false (fail to identify predation)

Question 3

What are some of the differing views on predation?

Answer 3

• Chicago school: predation = irrational
• Deep-pocket theory: predation can be rational and observed

Question 4

What is the rationale behind the Chicago School’s view on predation?

What are the underlying assumptions?

Answer 4

• predation = irrational
• assumes that a bank will always lend to the E in order for them to continue being prey
• I incurs loss with predatory pricing;
• rational E would remain prey until I stops pricing aggressively
• rational I would never undertake predation in first place

Question 5

What is the rationale behind the Deep-pocket theory?

What are the underlying assumptions?

Answer 5

• predation = can be rational and observed
• assumes that I has deep pockets;
• that E will obtain loan with a certain probability
• Both I and E will take into account the probability of E’s loan and incorporate this into their potential profits…
• I will be a predator if its (prob. Adjusted) monopoly profits > cost of predation + (Prob adjusted) duopoly profit
  [- E will be prey if the cost of predation < (prob adjusted duopoly profits)]

Question 6

Under what other conditions may predation be an optimal strategy?

Answer 6

• cost signalling
  ^can undertake a low price (high output) to show its low costs
• reputation for toughness as a deterrent (in other markets)
• (network effects) in 2 sided markets
  ^ lower p to attract large base