Limit Pricing
What is Limit Pricing?
Limit pricing is when an established firm sets a price low enough that entry would be unprofitable, giving up profit now to keep potential rivals out.
An incumbent charging the profit-maximizing price advertises how attractive its market is. Limit pricing instead sets a price just below the level at which a potential entrant could cover its own average total cost, so the newcomer projects a loss and stays away. The strategy only works if the incumbent genuinely has a cost advantage, usually from economies of scale or from an established volume the entrant could not match at first. The incumbent trades lower profit today for a longer run of profit without rivals. This is not predatory pricing: a limit price still covers the incumbent's own costs and is aimed at firms that have not entered, while predatory pricing goes below cost to force out a rival already in the market.
Limit Pricing: a worked example
An incumbent produces at an average total cost of $6 while a newcomer, starting small, would face $9. Left alone it would charge $14 and sell 40,000 units, earning (14 - 6) × 40,000 = $320,000. Instead it charges $8 and sells 100,000 units, earning (8 - 6) × 100,000 = $200,000. The $120,000 it gives up buys deterrence: at $8 the entrant would lose $1 on every unit, so it stays out. If entry would cost the incumbent more than $120,000 a year in lost profit, the lower price is the better deal.
The mistake students make with limit pricing
Students picture the incumbent pricing at a loss to scare newcomers off. A limit price sits above the incumbent's own average total cost, so the firm stays profitable; it is only below the price that would maximize short-run profit. The strategy also needs a cost advantage: if a potential entrant could produce just as cheaply, any price low enough to deter it would leave the incumbent losing money too.
Limit Pricing questions
What is the difference between limit pricing and predatory pricing?
Limit pricing holds price above the incumbent's own cost to discourage firms from entering, while predatory pricing drops price below cost to push out a rival that is already competing. The first sacrifices some profit, the second accepts an outright loss and depends on raising prices afterward.
Why would a firm charge less than the profit-maximizing price?
A firm charges below its short-run profit-maximizing price when a high price would attract entry that costs it more over time than the profit it gives up now. The calculation compares the profit sacrificed each year against the profit that would be lost permanently if a competitor arrived and stayed.
Is limit pricing illegal?
Limit pricing is generally treated as lawful competition, because the firm is charging a price that still covers its own costs and low prices benefit buyers. Antitrust concern begins when a dominant firm prices below cost with a realistic prospect of recovering the loss later, which is predatory pricing instead.
Formula / Example
This is the live Monopoly sandbox. Drag the curves, or open the full version.
Related terms
Common comparisons
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