Prohibitions against predatory pricing stem from big business conspiracy theories popularized in the late nineteenth century by journalists such as Ida Tarbell, author of an influential book titled History of the Standard Oil Company. In that book, Tarbell condemned Standard Oil's allegedly predatory price cutting. Business historians assert that Tarbell vilified John D. Rockefeller because of personal reasons, and not only because of an interest in reshaping public policy. Standard Oil's low prices had driven the employer of Tarbell’s brother, the Pure Oil Company, out of the petroleum-refining business.
According to predatory pricing theory, the predatory firm sets price below marginal cost, the relevant cost of production. Competitors must then lower their price below marginal cost, thereby losing money on each unit sold. If competitors failed to match the predatory firm’s price cuts, they would continue to lose market share until they were driven out of business. If competitors follow the lead of the predatory pricing firm and cut price below marginal cost, they will incur devastating losses, and eventually go bankrupt. Either way, the “deep pockets” of the predatory firm give it the financial muscle and staying power necessary to drive smaller, weaker competitors out of business. After competition has been eliminated from the market, the predatory firm raises prices to compensate for money lost during its price war against smaller competitors, and earns monopoly profits forever thereafter.
A. The ban against predatory pricing is one of the most controversial U. S. antitrust policies. Explain why this ban is risky from a public policy perspective, and why predatory pricing strategy can be criticized as irrational from a game theory perspective.
B. Explain why the prohibition against predatory pricing might be politically popular even if predatory pricing is implausible from an economic perspective.