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Predatory Pricing: The Elementary Economics

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Predatory Pricing: The Elementary Economics

Page 1

When Does Predatory Pricing Work?

The cost of predation equals the sum of the monthly sacrifice in profits over the k periods required to drive out the competitor, discounted to a present value.

Predator wants these to be SMALL:

  • Monthly Sacrifice
  • “P” — the number of months of predation
  • “i” — the monthly hurdle rate
VS.
The monthly return from predation equals the sum of the gain in each period from having fewer competitors in periods after the competitor exits, discounted to a present value, over the R periods available to recoup the costs of predation.

Predator wants these to be LARGE:

  • Monthly Return
  • “R”— the number of months of recoupment

An important asymmetry:

Slow Entry, but Quick Exits by Target Firms

Page 2

Detroit-Philadelphia
Northwest’s and Spirit’s Average One-Way Fares
for “True Local” Passengers

[D]

Page 3

Detroit-Boston
Northwest’s and Spirit’s Average One-Way Fares
for “True Local” Passengers

[D]

Detroit-Boston
Northwest’s Fare Distribution for
Local Passengers Before the Alleged Predation
1995 Q2 – 1995 Q4

Page 4

[D]

Updated June 25, 2015