Introduction To Limit Pricing Strategy

A monopoly is a market structure in which there is a single seller (Hendrikse, 2003) indicating the incumbent firm has price setting power- and the buyers are price takers. Remaining as a monopoly can have advantages in terms of market power, controlling and dictating the market, meaning they can charge prices that are abnormally profitable.

Clearly, it is an attractive prospect for any firm to be in the position of a monopoly. That is why, firstly, the incumbent firm will want to deter potential entrants, and secondly, why potential entrants want to enter. Throughout this essay, strategies that can be adopted by a firm in a monopolistic position, with the goal of deterring entrants will be discussed and analysed.

The first area of strategies to look into is that of the structural barriers to entry. These barriers are defined by Bain (1956) as an incumbent’s ability to constantly raise prices above that of a competitive market, discouraging entry. These arise due to the fact that, structurally, the entrants are not as large as the incumbent- of

Limit Pricing strategy can be defined as a pricing strategy where the prices at which the goods are sold, will be unprofitable to other firms. It is the highest price that a firm believes it can charge without encouraging entry. For this model to hold, assumptions are put in place: firms are profit-maximising; the incumbent firm has an absolute cost advantage; there are a very large number of potential entrants; the potential entrants expect that the incumbent will maintain output constant at the pre-entry level (which, as a monopoly suggests, leaves a section of profitable demand that is not satisfied at the current price level), which is independent of the entrants’ decision. The result of this strategy is that the market becomes unprofitable for the entrant to enter, and the incumbent maintains an abnormal