The Basics
- Simple definition: A strategy where an existing firm sets prices low enough to discourage new competitors from entering the market.
- Core idea: Sacrifice some short-term profit to keep potential rivals out.
- Think of it as: A big firm charging just low enough that a new small firm can’t cover its costs if it tries to enter.
What It Actually Means
Limit pricing occurs when a dominant firm sets its price below the short-run profit-maximizing level to make entry unattractive. Potential entrants look at the market price and their own costs; if the price is too low for them to break even, they stay out. The limit price is the highest price the incumbent can charge while still deterring entry. Once the threat passes, prices may rise again.
Example
A large cement manufacturer in Pakistan might keep prices moderately low in a region where a new competitor is considering building a plant. Once the newcomer decides not to enter, prices could gradually increase.
Why It Matters
Limit pricing shows how dominant firms can maintain market power without explicitly colluding. It’s harder for regulators to prove than price-fixing but equally harmful to competition.
Don’t Confuse With
Predatory Pricing – limit pricing deters potential entrants; predatory pricing drives out existing competitors, often with temporary prices below cost.
See also
Barriers to Entry • Predatory Pricing • Oligopoly • Bain’s Limit Pricing Theory
Read more about this with MASEconomics:
Bain’s Limit Pricing Theory and Strategic Firm Behavior: A Deep Dive