Limit Pricing and Potential Competition

Abstract

In the August 1967 issue of the Journal of Political Economy, Roger Sherman and Thomas Willett (S-W) demonstrated that within the framework of the Bain-Sylos-Modigliani model increasing the number of potential entrants not lower the entry-forestalling limit price; instead, it will usually raise it.1 The policy implications of this result are quite the opposite of what limit-price theorists have suggested. Rather than attempting to promote or maintain potential entrants (as, for example, the government claimed its goal to be in the prosecution of Procter & Gamble in the Clorox case),2 policy, guided by the S-W conclusions, should be aimed at discouraging these potential competitors, for as their numbers increase so may the effective limit price which may be charged.3 Most economists would, we daresay, agree that the S-W result is counterintuitive. The source of the difficulties is a single assumption in the BainSylos-Modigliani model; with a modification of this assumption we will show that increasing the number of potential competitors will, in general, lead to a lower limit price. Most limit-price analyses utilize an either/or approach: either the oligopolists attempt to maximize short-run profits and disregard the possible entry consequences, or they set price at a level which will deter all entry. Thus, in figure 1, p1 would be the limit price;