Limit Pricing Definition
Limit Pricing refers to the strategy to restrict the entry of new supplier into the market by reducing the price of the product and increasing the level of output of product and creating such a situation which becomes unprofitable or very illogical for the new supplier to enter into the market and grab the existing market customer base.
Limit Pricing is a concept which could not be beneficial in the long run as the enterprise or supplier could not work on zero levels of profits for long, this is a technique used by the supplier to keep its customer base or to retain the existing customer of the supplier with himself and restricts the entry of new supplier by reducing the price of the product by which he enjoys the benefit of no entry of new entrants and thereafter again enjoying its monopolistic market benefits by again charging such price which he wants to charge for his product.
Under this situation, the new entrants will try to enter into such market and tries to also earn such heavy profits in monopolistic market by supplying the product which is in short supply at much higher prices but the existing supplier will manipulate and by applying these techniques restrict such entry and continues such monopolistic market benefits.
Example of Limit Pricing
Let us take an example of two company namely Company A and Company B which are in the manufacturing industry. Company A is an established company and enjoying the monopolistic market whereas Company B is ready to enter into the market by gathering all required information and wants to enjoy the benefit of a monopolistic market.
Now to restrict the entry of Company B from entering into the market, Company A will reduce the prices of the product at such level where the company will only recover its cost and will earn the minimum or NIL profits along with increasing the level of output to the maximum as it’s a well-settled economic law that supply and price of product are inversely related i.e. lower the supply higher will be the cost of product and vice versa, to keep away the new entrant from the market. Now in the above situation Company B will have to rethink twice whether to enter the market or not in such a situation.
- It was seen that in a monopolistic market, the supplier of goods is charging high rate for their goods due to lack of competition in the market, so to enter into the market and enjoys such monopolistic situation many new entrants try to enter into the market, then the existing supplier will use this technique and reduce the price of the product at much lower levels and increase the level of output at much higher levels so that it becomes impracticable to the new entrants to enter into the market.
- This technique is only a way to keep out the new entrants from the market and continue enjoying the monopolistic market.
Limit Pricing vs Predatory Pricing
The major differences between Limit Pricing vs Predatory Pricing are as follows –
- Limit Pricing is a strategy used by the existing supplier to restrict the entry of new entrant which are currently out of the market but on the other hand, predatory pricing is a strategy which is used by one supplier to out the other supplier existing in the market.
- Under Limit Pricing the existing supplier will reduce the price and increase the output to restrict the entry of new supplier but on the other hand predatory pricing strategy the existing supplier will be thrown out of the market along with the restriction on new entry of suppliers, in other words, it is wider in scope.
- It is very easy to prove that the strategy of Limit Price is applied by the supplier in the market but on the other hand, it is very difficult to prove the applicability of predatory pricing strategy.
- Under Limit Price the supplier will have to earn lower profits for some time to keep out the new entrant but on the other hand, it is not required.
- It helps the existing supplier to keep the market out of the reach of other new entrants or suppliers.
- The consumer in such a situation will be benefited as the product will be available in the market at lower costs.
- As the concept of Limit Pricing is lowering the price of the product to be charged and increase the output, the small suppliers will not be able to adopt such technique as this would not be profitable to them.
- As there are only a few suppliers and new entrants are not allowed to enter the market it gives lower revenues to the government and the customer will have to pay more for such products.
- After a particular point in time, the consumer will understand the situation that this is a technique being applied by the supplier to restrict the new suppliers from entering the market.
Limit Price is a technique used by many new entrants to establish their customer support or by the existing supplier to not to allow any new supplier to enter into the market, this is a methodology which is mainly used in monopolistic markets as there are no competitors and supplier could charge any amount of money against the supply of its goods. The concept is banned and illegal nowadays in most of the countries.
This has been a guide to Limit Pricing and its definition. Here we discuss an example, evaluation of limit pricing along with advantages, disadvantages, and differences from predatory pricing. You may learn more about financing from the following articles –