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Why Above-Cost Price Cuts To Drive Out Entrants Are Not Predatory--and the Implications for Defining Costs and Market Power |
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Einer Elhauge [View as PDF]
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112 Yale L.J. 681 (2003)
Recently, European and U.S. officials have made surprising moves toward restricting firms from using above-cost price cuts to drive out entrants. This Article argues that these legal developments likely reflect the fact that scholarly critiques of cost-based tests of predatory pricing have never been satisfactorily addressed, and offers a better explanation for why restrictions on reactive above-cost price cuts are undesirable. It begins by concluding that ¿costsî should be defined functionally as whichever cost measure assures that prices above costs cannot deter or drive out equally efficient rivals, and shows how applying that functional benchmark resolves numerous apparent anomalies in current predatory pricing law. It then shows that reactive above-cost price cuts do not necessarily indicate an undesirable protection of market power, but rather can be an efficient response to deviations from the output-maximizing price-discrimination schedule in competitive markets. Even when an incumbent does have market power, restrictions on reactive above-cost price cuts have mainly undesirable effects. They fail to encourage entry and raise post-entry prices in the bulk of cases, where the entrants are (or will predictably become) as efficient as the incumbent or would have entered anyway despite entrant inefficiency. They can only weakly encourage less efficient entry since the restrictions cannot protect less efficient entrants in the long run, and even in such cases they have mixed effects on post-entry prices since they give incumbents perverse incentives to raise post-entry prices to speed the day when the restriction expires. In all cases, they impose wasteful transition costs and losses in productive efficiency, and they lessen incentives to create more efficient incumbents and entrants. These adverse effects are worsened by implementation difficulties that cannot be avoided no matter how the rules are defined, including that possible definitions of the moment of entry or exit either make the restrictions ineffectual or make their adverse effects last far longer than any benefits from entry, that they inefficiently either increase or decrease innovation rates, and that any price floor or output ceiling will cause inefficiencies because of either great uncertainty or inflexibility in the fact of changing market conditions.
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