Pricing summary

  • Although price wars are expected to be damaging for the firms involved, they do break out from time to time
  • This may occur when firms wish to increase their market shares, or when existing firms wish to deter the entry of new firms into the market.
  • Predatory pricing is an extreme strategy that forces all firms to endure losses. It is normally invoked in an attempt to eliminate a competitor, and is illegal in many countries.
  • Limit pricing occurs when a firm or firms set a price below the profit maximising level in order to prevent entry. The limit price is the highest price that an existing firm can set without allowing entry
  • In some cases the limit price may enable to incumbent firm to make only normal profit. Such a market is said to be contestable
  • Contestibility requires that there are no barriers to entry or exit and no sunk costs – and that the incumbent firms have no cost advantage over hit and run entrants
  • Firms have adopted other strategies designed to deter entry, such as using advertising or R&D spending to raise the cost of entry  by adding to the required fixed costs
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