Topic > Introduction to Limit Pricing Strategy - 1429

A monopoly is a market structure in which there is a single seller (Hendrikse, 2003), which indicates that the dominant firm has the power to set prices and buyers are price takers. Remaining a monopoly can have advantages in terms of market power, control and market dictation, meaning they can command abnormally profitable prices. Clearly, it is an attractive prospect for any company to find itself in a monopoly position. This is why, first, the dominant firm will want to discourage potential entrants and, second, why potential entrants want to enter. In this essay, the strategies that can be adopted by a company in a monopolistic position will be discussed and analyzed, with the aim of discouraging new competitors. The first area of ​​strategies to be explored in depth is that of structural barriers to entry. These barriers are defined by Bain (1956) as the ability of an incumbent to consistently raise prices above those of a competitive market, discouraging entry. These arise due to the fact that, structurally, the new entrants are not as large as the incumbent. Limit pricing strategy can be defined as a pricing strategy in which the prices at which goods are sold will not be profitable for other companies. It is the highest price a firm believes it can charge without encouraging entry. In order for this model to hold up, hypotheses are put in place: companies maximize profit; the dominant firm has an absolute cost advantage; the number of potential entrants is very high; potential entrants expect the incumbent to keep production constant at the pre-entry level (which, as a monopoly suggests, leaves some portion of profitable demand that is unsatisfied at the current price level), which is independent of the decision of new entrants. The result of this strategy is that the market becomes unprofitable due to the entry of the new operator and the incumbent operator maintains an anomalous position.