Market Foreclosure (Predatory Pricing) Flashcards
Part 1 looks at how incumbents firms can prevent entry. (Through limit pricing below Pm, capacity choices, and investment choices K1)
How may firms FORCE existing firms out
Predatory pricing
Main distinguishing problem of predatory pricing
Is it the fall in price anti-competitive predatory or a simply a repsone to increased competition
Predatory pricing:
In period 1 what does firm 1 do if;
A) aggressive
B) soft
Sets price below their cost, so both firms make losses of L
B) if soft, share positive duopoly profits of πd
What happens in period 2 (2 possible outcomes)
If firm 2 exits the market, firm 1 earns monopoly profit.
If firm 2 stays in market, as only a 2-period model, firm 1 will be soft regardless so they earn duopoly profits
When will firm 2 always stay in the market
As long as it can cover first period losses i.e if πd>L
So firm 2 stays as long as πd>L,
(I,e do not mind losses in period 1 if firm 1 chooses hard)
So what should firm 1 be in period 1, if they believe firm 2 has access to finance
They should play soft (no point in predatory pricing to both incur losses L, since firm 2 can afford to!)
If firm 1 does not believe firm 2 has finance to cover losses, what should it do
B) what is this in expression form
It should be aggressive
B)
when they think…
πm - L >2πd (firm 2 cannot cover losses!)
Thus they should be aggressive!
Add probability p to firm 2 not securing finance
What does this do to our expression for when firm 1 should be aggressive
Be aggressive if
pπm + (1-p)πd - L > 2πd
What happens if we add more than 2 periods.
More incentive to force exit (common sense), accept greater losses to establish a reputation for toughness
Why does predatory pricing complicate competition polilcy
Consumer consideration : They dont want monopoly to abuse power and set high prices
But should they also consider producers? They don’t want predatory pricing forcing out other firms.
Spirit Airline example
Entered, Northwest Airlines cut their fares largely
Controversy whether response to increase in comp, or anti-competitive predatory pricing.
3 questions to assess whether actions were anticompetitive or simply a response to increased competition
Is existing market highly concentrated (if it is, increases likelihood of anti-competition)
Is P<AVC
Would the firm be able to quickly recoup losses
Product proliferation: a way to deter entry
A company offers a wide variety of products within the same category to capture larger share of market
Example of PP: breakfast cereals has low tech and low economies of scale, so barriers of entry are low so should be easy to enter.
Yet in US there are 4 firms earning significant profits. Why?
Product proliferation - amongst those firms, number of brands from them increased from 25 to 80.
Cover all gaps e.g chocolate, sugar coated, healthy
Bundling:
Consider firm 1, has a monopoly in one market (product A) but competing in a second market (product b) against firm 2
Firm 1 can either sell the 2 products individually or a single price to sell the two together (a bundle)
All Consumers have same valuation for A, different for the 2 types of B
Example of bundling:
Let microsoft be firm 1, selling Windows and internet explorer. Firm 2 sells netscape
Every consumer values Windows (product A) $50.
Group i values IE at 25, Netscape at 10
Group ii IE 10, Netscape 25
Group iii IE 10, Netscape 38
What is the equilibrium if bundling is not possible
Microsoft sells Windows for 50.
Both browsers are sold for 25 (Microsoft sells to group i, 1/3 market share)
But Netscape sells for ii and iii, so 2/3 market share.
What if bundling exist: microsoft can sell windows and IE together for 60
All consumers are willing to pay 60 for bundle since cannot buy windows seperately.
But are group ii and iii still willing to pay for netscape?
For group ii, are they willing to still buy netscape?
B) what about group iii
Windows and netscape valued at 75, but bought windows and IE at 60.
So will only pay 15 for netscape.
B) Windows and netscape valued at 88.
So will only pay 28 for netscape
Which is better for Netscape
They earn more by pricing at $15, in order to capture group ii and ii’s demand, to maintain 2/3 of market. (Rather than pricing at $28 to only group iii willing to pay)
Does microsoft benefit from bundling together?
Yes, earns more than when it was selling separately, as previously only sold 1/3 of the market at 25.
Now assume Netscape has to pay fixed cost.
What happens if fixed cost if 15<F<25?
Microsofts bundling would force Netscape out the market
Hence bundling a form of foreclosure!
(Intuition, people see they already have a browser, so do not demand the other one!)
In 1995 Microsoft signed a consent decree to not tie other software to Windows. Explain case
IE was bunched with windows. Case against them for violating consent decree.
Microsoft argued IE was a feature of windows, not a separate software.
Ruled against microsoft, were forced to split windows and other software
Exclusivity contracts:
an input seller is a monopolist, with a potential entrant.
They offer a contract to buyers, where pay less than Pm, but exclusivity (they only buy from the monopolist)
What does the buyer’s decision to accept depend on?
Probability of new entrant (if unlikely… perhaps accept price close to Pm…)
Size of discount
Buyer’s patience
One potential outcome of market foreclosure
A proportion of buyers sign the contract
Remaining have to pay Pm.
Potential entrant does not enter (since not enough customers left to sell to to be profitable
Vertical restraints
Restrictions placed in agreements between firms at different levels of supply chain
E.g producers (upstream) to retailers (downstream)
Example of vertical restraints: Unilever & Mars
Unilever exclusivity contracts with small retailers: agreed to supply freezers to
But only could be used for unilever ice cream; excluding rivals from market!
Mars responded with own freezers.
Found both anticompetitive: had to change their agreements to allow more freedom in use of freezers.
