Other Pricing Policies (Cambridge International A-Level Economics)

Limit pricing

• Limit pricing occurs when a firm sets a price below the short-run profit-maximising level to deter new firms from entering the market

  • Common in monopolies and oligopolies

Why do firms use limit pricing?

• Prevents entry by making the market appear unprofitable
• Protects long-run supernormal profit
• Acts as a barrier to entry

Key features

• The price is set low enough to discourage entry, but high enough to still earn profit

• Firms often:

  • Increase output
  • Exploit economies of scale

• More effective when:

  • Barriers to entry are already high
  • Incumbent firms have cost advantages

Limitations

• Firms sacrifice short-run profit

• May not work if:

  • New firms have lower costs
  • Market demand is growing rapidly

• Difficult to sustain in the long run

What is price leadership?

• Price leadership occurs when one dominant firm (price leader) sets the price, and other firms (followers) adjust their prices accordingly

  • Common in oligopolistic markets

Types of price leadership

• Dominant firm leadership → largest firm sets price
• Barometric leadership → most informed firm sets the price
• Collusive leadership → firms informally agree on a leader

Key characteristics

• Firms avoid price wars

• Prices are relatively stable

• Competition shifts to:

  • Non-price factors (branding, quality, advertising)

Diagram analysis

• The price leader (Firm A):

  • Produces where MCₐ = MR
  • Sets price at Pₐ from the demand curve

• The follower (Firm B):

  • Has higher costs → its profit-maximising price would be Pᵦ
  • But must match Pₐ to remain competitive

• Therefore:

  • Firm B earns lower profit (or may make losses)
  • Firm A gains a cost advantage

Evaluation of price leadership

Predatory pricing

• Predatory pricing occurs when a firm deliberately sets a very low (often below cost) price to force competitors out of the market

Why do firms use predatory pricing?

• Eliminate existing competitors
• Deter potential entrants
• Increase market power

Key features

• Prices may fall below average cost (AC)

• Firms make short-run losses

• After rivals exit:

  • Firm raises prices
  • Earns supernormal profit

Limitations

• Very expensive strategy (requires financial reserves)

• Competitors may:

  • Survive (e.g. government support)
  • Retaliate with price cuts

• Often illegal under competition law

• Hard to prove in practice

Case Study Context

In the 2010s, Uber expanded rapidly into global ride-hailing markets, including the US, India, and Southeast Asia. It faced strong local competitors such as Lyft (US) and Grab (SE Asia). Markets were highly competitive with low switching costs for consumers

Strategy

• Uber used predatory pricing tactics by:

  • Offering heavily discounted fares
  • Providing driver incentives and bonuses

• Prices were often set below cost, leading to large short-run losses

• The aim was to:

  • Undercut rivals
  • Gain market share quickly
  • Force weaker competitors to exit

Outcome

Several competitors were driven out or acquired

• Uber sold its Southeast Asia operations to Grab (2018) after intense losses

In markets where competition weakened:

• Prices began to rise
• Uber moved closer to profitability

However

• Regulators have investigated Uber for anti-competitive behaviour
• The strategy proved costly and risky, with sustained financial losses

Exam Hint An excellent evaluation point in essays for questions that include predatory pricing is 'Predatory pricing may eliminate competition in the short run, but it involves significant losses and regulatory risk'