Blackwell Reference Online

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When a firm practices limit pricing it chooses its price (and therefore output) in such a way that the remaining market demand ( residual demand ) is insufficient for an entrant to cover its average total cost . As originally described by Modigliani (1958) , if an established firm were threatened by entry in a single period, the limit price is the highest price it could charge without allowing entry to occur. Naturally, the limit price that would accomplish this objective depended on the expectations of potential entrants. Modigliani assumed that entrants would expect the established firm to continue producing at the entry‐limiting output even if entry occurred, equivalent to the assumption of C ournot competition, where each firm believes its rivals will continue to produce at current levels. If there are economies of scale in production, limit pricing would allow established firms to earn economic profits while preventing entry, even when entrants have the same costs as incumbent firms ( see economic profit ). Gilbert (1989) refers to this pricing policy as “classic limit pricing.” Gaskins (1971) extended this model to consider dynamic limit pricing where a firm is threatened by potential competition in the current period and in future periods, and where the rate of entry by new firms depended on the difference between the current price and their marginal costs. If ... log in or subscribe to read full text