Exam Answer: Predatory Pricing

Here is a suggested answer to this question: "Explain how a firm may use predatory pricing."

Predatory pricing is a deliberate strategy of driving competitors out of the market by setting very low prices or selling below AVC. The aim of predatory pricing is to reduce competition and increase the monopoly power and profits of firms who benefit from it.

Predatory pricing tactics can be used by both existing firms and also by new entrants into a market. Established firms may decide that they can absorb losses for a short while by drastically cutting their prices, perhaps below AC or even AVC as shown in my diagram.

As a result, they are likely to pick up a lot of extra market share from other suppliers in the market. The losses are shown in the shaded area (revenues are unable to meet even variable costs in the short run).

But if predatory pricing is successful, then monopoly power is built up and the firm can then use their market dominance to increase prices in the long run to achieve higher levels of supernormal profit.