Predatory Pricing

Predatory pricing is defined as "pricing at a level calculated to exclude from the market an equally or more efficient competitor. Pricing at a level to exclude a less efficient competitor is, of course, what competition is supposed to do" [Viscusi, Vernon, and Harrington p. 272].

Evidence of predation can go a long way toward establishing "intent to monopolize" in a § 2 case. But is there an operational definition of predatory pricing available to the courts? For example, 3 Conway, AR drug retailers alleged that Wal-Mart engaged in predatory pricing in the local market for over-the-counter drugs. Wal-Mart responded that it was merely giving consumers the benefit of volume discounts extracted through large scale buying and tough negotiating with the pharmaceutical companies. What test might be indicated to resolve a question like this?

	The Areeda Turner test for predatory pricing [see P. Areeda and D. Turner, "Predatory Pricing and Related Practices Under Section 2 of the Sherman Act, " Harvard Law Review, March 1975] has some currency among judges these days.
	The Areeda Turner suggest the following simple legal definition of predatory pricing: "A price below reasonably anticipated average variable cost [AVC] should be presumed unlawful." Click here to view the graph.
	Some antitrust scholars argue that predatory pricing is extremely rare. Moreover, a profit-maximizing firm has a weak incentive to engage in predation since it must incur short-run losses to do so.
	Robert Bork, for example, criticized the Areeda-Turner test as follows: "It seems unwise . . . to construct rules about a phenomenon that probably does not exist or which, should it exist in very rare cases, the courts would have grave difficulty distinguishing from competitive behavior"[Bork, The Antitrust Paradox].
	Economic historian John McGee is sharply critical of the view that the predatory pricing played a significant part in the rise of Standard Oil [ See McGee, "Predatory Pricing Cutting: The Standard Oil Case," Journal of Law and Economics, October 1958].
	McGee points out that, taking into account the time value of money, a $1 loss in the current period must be offset by a greater than $1 profit in future periods. For example, suppose the discount rate applied to expected future profits is 10 percent. Additionally, suppose that future increase in profits realized by obliterating the competition now are expected to be distributed over a three year time horizon.
	Issue: What increase in expected future profits in years 2 through 4 would be required to compensate the firm for $186, 514 in losses in year 1 (associated with predation)? Click here to find out.

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