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There is a well worn belief that not all forms of price reductions by firms are socially beneficial. Such price cutting is typically referred to as “predatory pricing.” In other words, while you and I and most rational people understand that when firms lower prices, this is a reflection of improved efficiency on their part, and a boon to consumers and to producers of other goods and services, some argue that social welfare is actually hurt sometimes when prices are cut.

Before we proceed, remember too that there is a large group of people who disdain price increases (gouging) and static pricing (collusion), which makes it a Sisyphian effort to now discuss whether price decreases (predation) are an economic concern – you see, for anti-market fundamentalists, prices themselves are evil, that is the only way to make sense of people holding all three beliefs, and also having developed a philosophy that there is some sort of “right” price to be found somewhere.

Now, onto the specifics of predatory pricing. What I’d like to discuss today about whether price cutting can be socially harmful, but rather to accept the position of the critics that it is, and then ask, what is a policymaker to do about it? The goal of policy would be to find only those price cuts which were deemed socially harmful – and make sure that competition is channeled into places that will benefit consumers such as new products, better quality products and useful price reductions.

Predatory pricing is a typical class of price reductions which are not reflections of better efficiency, but rather efforts by firms to monopolize the market by making it impossible for rivals to compete, forcing them to either exit the industry, reduce output or be taken over by the “predator.” There is, as of yet, no harm to consumers. It can only come after the competing firm acquiesces when the surviving firm “jacks up” prices without fear of other competitors. Never mind the frailty of such a theory and its lack of ever having been observed, let’s continue to maintain that this outcome happens regularly.

How is a policymaker to distinguish between price reductions that are beneficial to consumers and ones that are harmful to consumers? Think about what would have to be true for a firm to be able to lower its prices at all, or to engage successfully in a “war” with other firms. Such action would have to be related to that firm’s efficiency. If this is so, then merely looking at whether there is a price war is not enough to tell us whether predatory behavior is happening. Why? Because stopping price wars would be simply preventing consumers from getting the benefits of truly competitive pricing – the war may be forcing firms to price more in line with costs in the first place!

When we are talking about other ways can punish their rival firms, then it is rather easy to identify acts which are beneficial from acts which are not. For example, if Target bombs all of the Walmart stores in an area, that’s a good sign of some bad dealing. And the fact that one firm is able to be violent to another says nothing about whether that firm is more efficient than another. On the other hand, a policymaker cannot look at low prices (and hence damage to potential entrants) as a sign that consumers will be hurt. Trying to “do something” about predatory pricing will likely throw out the baby with the bathwater.

In our next post, we’ll examine whether in theory there can be a way to make such a determination. And in another future post, we’ll return to the more fundamental question of whether price cutting can be socially harmful and to what extent we should be concerned about it.

3 Responses to “Knowledge Problem Application: The Case of Predatory Pricing”

  1. Speedmaster says:

    So if the prices are the same it’s ‘collusion’, if they’re deemed to high it’s ‘gouging’, if they’re too low it’s ‘predatory’.

  2. Speedmaster says:

    Three gas station owners report for their first day in prison. The prison guard asks one of them, ‘What are you in for?’ He replies, ‘The government says I charged customers more for my gasoline than other gas stations. I’m in for price gouging.’

    The guard looks at the second man. ‘And you?’ He answers, ‘I charged less for my gasoline than everyone else. I’m in for anti-competitive pricing.’

    The guard looks to the third. ‘And you?’ He shrugs. ‘I charged the same price for my gasoline as all the other gas stations. I’m in for collusion.’

  3. […] examined whether it was even possible in principle to determine if a company was engaging in “socially harmful” predatory pricing. Today we’ll address whether there is even a theoretical possibility […]

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