Market Performance under Dynamic Limit Pricing

If entry costs are sufficiently small, the monopolist would have to expand output greatly to prevent entry. In this case, the most profitable thing for the dominant firm to do is to set a higher price and give up market share. Eventually, the market will be supplied by several firms of roughly equal size. Such markets – oligopolies – are important, because they are the most common form of real – world market. We study them in the next two chapters. Here we simply note that firms in such markets will, in general, be able to exercise some market power.

At the other extreme, if there are no entry costs at all, the market is constable. If average cost is the sane for the entrant and the dominant firm, the dominant firm will be unable to exercise any market power without losing the entire market to the entrant. The market will perform as a competitive industry, even though it is supplied by a single dominant firm. Read more…

Dynamic Limit Pricing (II)

In fringe firms can increase their output rapidly and take market share away from the dominant firm quickly, the dominant firm the gain little by setting a high price. High short – run profits will evaporate quickly, as will market share. When fringe firms can expand rapidly, a dominant firm is more likely to hold the price down and retain market share. Discount Rate

The third factor that determines the dominant firm’s choice is the discount rate. When the discount rate is high, current income can be invested at relatively high rates of return. The opportunity cost of postponing current income for future income is high. If the discount rate is high enough, the dominant firm will prefer to take a greater profit in the short run and give up market share. Read more…

Market Performance under Entry – Limiting Behavior

How does the presence actual or potential of a competitive fringe affect market performance? How much control over price is a dominant firm able to exercise, compared with competition and monopoly?

The answer, of course, is, “it depends” as it is to almost all question in economics. In most of the classes that use this text book, however, you will not get much credit for that answer unless you are able to explain what market performance depends on. It is no that topic that we now turn.

First, consider the static limit price model. If entry is blockaded – if the dominant firm can charge the monopoly price and if it is still not profitable for new firms to come into the market – we are back to the basic monopoly model of chapter 2. The only limit on the exercise of market Read more…

Dynamic Limit Pricing (II)

Three factors determine which alternative will yield a dominant firm the greatest present discounted value. The first factor is the difference between the limit profit the firm will earn if it sets a low price and the larger short – run profit it will earn if it sets a high price. The second factor is the rate at which the dominant firm loses market share and therefore profit to the fringe if the fringe begins to expand. The third factor is the discount rate.

Here we can draw on the conclusions of the static limit price model. If the market is the large and entry costs are small, the limit price will near marginal cost and the limit profit will be small. The smaller the per – period limit profit, the more likely it is that the dominant firm will achieve a greater present discounted value income stream by taking a larger short – run profit and giving up market share over the long run. If the market is large enough and entry costs are small enough, the dominant firm will prefer to take such short – run profits as it can get, even at the expense Read more…