Case Scenario:
According to predatory-pricing theory, the predatory firm sets price below marginal cost, the relevant cost of production. Competitors must then lower their prices 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 lst during its price war against smaller competitors and earns monopoly profits forever thereafter.
Question 1: The ban against predatory pricing is one of the most controversial U.S. antitrust policies. Explain why this ban is risky form a public policy perspective, and why predatory-pricing strategy can be criticized as irrational from a game-theory perspective.
Question 2: Explain why the prohibition against predatory pricing might be politically popular even if predatory pricing is implausible from an economic perspective.