Question

Explain the economic basis for predatory pricing.

Short answer

The economic reason behind predatory pricing drives potential rivals out of the market.

Step-by-step solution

Predatory Pricing

It refers to the strategy where a firm temporarily sets its price lower than its marginal cost to drive away competitors from the market.

Economic basis for predatory pricing

This case can only be possible when the predator reducing the price should have the present value of future profits exceeding the current losses the firm bears. At the same time, the rivals or the so-called prey are the ones who are to be driven away due to the market condition.

Here, the predator is considered to be healthier than the prey. This situation would eventually result in rivals either leaving the market or selling out to the more prominent firm at a bargain price rather than leaving the market.

Although the predator firm might be successful in posing a threat to their rivals, the predatory pricing also has its negative impact. Such a condition leads to the drainage of the predatory firm compared to the prey firm.

The prey firm might buy the products at a lower cost and sell them later after the predatory price ceases. Comparing both, the predatory firm faces more costs than the prey firm.