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| {{Competition law}}
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| A '''limit price''' (or '''limit pricing''') is a price, or [[pricing strategies|pricing strategy]], where products are sold by a supplier at a price of which is lower than the average cost of production or at a price low enough to make in unprofitable for other players to enter the market.
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| It is used by [[monopoly|monopolists]] to discourage entry into a [[market]], and is illegal in many countries.<ref>[[Paul Milgrom]] and [[Donald John Roberts|John Roberts]], 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," ''Econometrica'', 50(2). pp. [http://levine.sscnet.ucla.edu/archive/refs4245.pdf 443-459.]</ref> The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher [[economic profits]] than would be earned under [[perfect competition]].
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| The problem with limit pricing as strategic behavior is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's [[best response]]. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time.<ref name="Carlton">Dennis W. Carlton and Jeffery M. Perloff, 2004. ''Modern Industrial Organization'', 4th edition, [http://www.lavoisier.fr/notice/frSWORK23A3RW32O.html Description.]</ref> Another example is to build excess production capacity as a commitment device.
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| ==Simple Example==
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| In a simple case, suppose industry [[demand]] for good X at market price P is given by:
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| <math>\mathsf{Q^D} = a - bP</math>
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| Suppose there are two potential producers of good X, Firm A, and Firm B. Firm A has no [[fixed costs]] and constant [[marginal cost]] equal to <math> c > 0 </math>. Firm B also has no fixed costs, and has constant marginal cost equal to <math>gc</math>, where <math>g > 1</math> (so that Firm B's marginal cost is greater than Firm A's).
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| Suppose Firm A acts as a monopolist. The profit-maximizing monopoly price charged by Firm A is then:
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| <math>p^M = \frac{a + cb}{2b}</math>
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| Since Firm B will never sell below its marginal cost, as long as <math>p^M \le gc</math>, Firm B will not enter the market when Firm A charges <math>p^M</math>. That is, the market for good X is an effective monopoly if:
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| <math>g \ge \frac{a + cb}{2cb}</math>
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| Suppose, on the contrary, that:
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| <math>g < \frac{a + cb}{2cb}</math>
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| In this case, if Firm A charges <math>p^M</math>, Firm B has an incentive to enter the market, since it can sell a positive quantity of good X at a price above its marginal cost, and therefore make positive profits. In order to prevent Firm B from having an incentive to enter the market, Firm A must set its price no greater than <math>gc</math>. To maximize its profits subject to this constraint, Firm A sets price <math>p^L = gc</math> (the limit price).
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| ==References==
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| {{reflist}}
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| ==See also==
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| *[[list of economics topics]]
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| *[[Predatory pricing]]
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| *[[Strategic entry deterrence]]
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| [[Category:Monopoly (economics)]]
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| [[Category:Pricing]]
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| [[Category:Anti-competitive behaviour]]
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| [[Category:Industrial organization]]
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