How does predatory pricing work in an imperfectly competitive market?

Predatory pricing in an imperfectly competitive market involves a dominant firm setting prices low to eliminate or hinder competition.

In an imperfectly competitive market, there are a few dominant firms that have the power to influence the market price. Predatory pricing is a strategy used by these firms to set prices so low that other competitors cannot match them and, as a result, are forced out of the market or deterred from entering it. This strategy is often temporary and is abandoned once the firm has achieved its objective of reducing competition.

The process begins with the dominant firm drastically reducing its prices. This move forces other firms to also lower their prices to remain competitive. However, smaller firms or new entrants may not have the financial resources to sustain these low prices for a long period. They may incur losses and eventually exit the market. Once the competition is eliminated or significantly reduced, the dominant firm can then increase its prices and enjoy higher profits.

However, predatory pricing is a risky strategy. It requires the dominant firm to sustain losses in the short term with the hope of recouping these losses in the future when prices are increased. There is also the risk that competitors might withstand the period of low prices or that new firms might enter the market once prices are increased.

Moreover, predatory pricing is often viewed as anti-competitive behaviour and is illegal in many jurisdictions. Regulators such as the Competition and Markets Authority in the UK are tasked with ensuring that markets remain competitive and that firms do not abuse their dominant position to the detriment of consumers or other businesses.

In conclusion, predatory pricing in an imperfectly competitive market is a strategy used by dominant firms to reduce competition by setting prices low. While it can lead to higher profits in the long term, it is a risky strategy that can lead to financial losses and potential legal issues.