Hunting unicorns? Experimental evidence on predatory
pricing policies
Aaron Edlin, Catherine Roux, Armin Schmutzler, Christian Thöni
ECON
November 2015
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
1 / 32
1 Introduction
1.1 Overview
Previous legal and economic literature has debated whether
below-cost predatory pricing is a relevant phenomenon
This paper considers above-cost predatory pricing (Edlin 2002):
Low-cost monopolists may engage in post-entry price cuts;
anticipation of these price cuts will prevent entry, in spite of high
prices
We investigate whether standard and non-standard policies against
predatory pricing can help
We provide experimental evidence con…rming some aspects of theory
(and leaving some puzzles)
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
2 / 32
1 Introduction
1.2 Below-cost predatory pricing
Below-cost predatory pricing: Setting prices below costs with the goal
of inducing exit or preventing entry in order to increase pro…ts in the
long term
Several legal cases have dealt with the phenomenon
Chicago arguments have been put forward against it: with symmetric
…rms, it is hard to recoup the short-term pro…t losses
Game theoretic arguments can support the idea: long purse, signaling,
repeated games
Real-world evidence is rare
Experimental evidence is mixed
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
3 / 32
1 Introduction
1.2 Below-cost predatory pricing
Are there so many theories of predation because it “is a common but
variegated phenomenon” or rather “for the same reason that 600 years
ago there were a thousand positions on what dragons looked like”?
“There is no su¢ cient reason for antitrust law or the courts to take
[predation] seriously.” Easterbrook (1981)
“Rare like an old stamp or rare like a unicorn?” (Elzinga, cited in
Goeree et al., 2004)
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
4 / 32
1 Introduction
1.3 Above-cost predatory pricing
Idea (Edlin 2001):
An e¢ cient …rm that faces an ine¢ cient potential entrant can
credibly threaten to limit price the entrant
This does not require going below the monopoly price pre-entry
Possible Problem: Incumbent can set the monopoly price, even
though entry plus limit pricing would yield higher welfare
Standard policy measures do not address the problem:
Brooke Rule requires above-cost pricing: would not be violated by this
behavior
Baumol Rule requires keeping prices low post exit: does not attract
entry
Edlin Rule requires not lowering price too much after entry: Can this
induce entry and/or reduce prices?
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
5 / 32
1 Introduction
1.3 Above-cost predatory pricing
Basic empirical challenge:
If entrants do not enter for fear of predatory pricing, above-cost
predatory pricing may have an e¤ect without ever being observed
But if we see "insu¢ cient entry" in the …eld, when can we attribute
this to fear of above-cost predatory pricing?
It would be necessary to compare entry in a laissez-faire environment
and one where above-cost predatory pricing is di¢ cult for legal
reasons.
But how? –> Lab experiment
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
6 / 32
1 Introduction
1.4 Role for a lab experiment?
Not:
Show that the SPE is (not) played
Find evidence for social preferences
Instead:
Understand whether fear of an anticipated o¤-equilibrium event can
in‡uence decisions
Allow for policy experimentation under similar conditions
Understand how players choose between various “somewhat rational
alternatives”
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
7 / 32
1 Introduction
1.5 This paper
Theory:
In the SPE of …nitely repeated versions of "above-cost predatory
pricing games" there is no entry along the equilibrium path:
trivial with Laissez-Faire and Brooke rule
messy with Baumol and Edlin rule
prices are below monopoly only in the Edlin case
Experiment:
Entry deterrence at monopoly price is frequent, except in Edlin case
In the Edlin case, pre-entry prices are lower, and there is more entry
In all cases, there are price wars after entry
In all cases except Baumol, prices are at the monopoly level after exit
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
8 / 32
1 Introduction
1.6 Overview
1
Introduction
2
Experimental Set-Up
3
Theory
4
Experimental Results
5
Discussion
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
9 / 32
2 Experimental Set-Up
2.1 Overview
four treatments: LAISSEZ-FAIRE, BROOKE, EDLIN, BAUMOL
seven rounds per treatment, each consisting of a four-period game
two …rms L and H with marginal costs cL < cH can produce a
homogenous good with demand D (p )
in stage 1, …rm L decides whether to incur …xed costs F of
production, sets price thereafter
in stages 2-4, both …rms simultaneously decide on participation, then
simultaneously choose prices
exit is irreversible
perfect information
no …nancial constraints
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
10 / 32
2 Experimental Set-Up
2.2 Treatments
De…nition
An incumbent in period t is a …rm that had a market share of one in
period t 1 and is present in period t
LAISSEZ-FAIRE: No restrictions on prices.
BROOKE: An incumbent is not allowed to price below its own
marginal cost in duopoly periods.
EDLIN: An incumbent is not allowed to price below η times its
previous price (η 2 (0, 1)) when the competitor is present.
BAUMOL: If the competitor exits in period t after a duopoly period,
an incumbent is not allowed to increase its price in period t or any
later period.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
11 / 32
2 Experimental Set-Up
2.3 Parameters
D (p ) = 80
p
Price space: [0, 80]
cH = 30
cL = 20
F = 250
η = 0.8
Moreover:
Firms with equal prices share the market
Without entry, …rms earn 50. Entry costs 200.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
12 / 32
3 Theory
3.1 Overview of Critical Prices
pHB , pLB : break-even prices
p M (cH ), p M (cL ): monopoly prices
p such that 0.8p = pLB : entry-deterring price (Edlin)
Overview of Prices
0
20 24.5
cL
pB
L
30
35.6
cH
pB
H
44.5
50
55
80
p⇤ pM (cL ) pM (cH )
Note: pLB < cH ; p < p M (cL )
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
13 / 32
3 Theory
3.2 Tie-Breaking
(T1) In any situation where both …rms charge the same price, but a
pro…table short-term downward deviation for exactly one …rm is
feasible, this …rm wins the entire market (and becomes the incumbent
in the next period).
Examples: (pLt , pHt ) = (cH , cH ); (0.8pLt 1 , 0.8pLt 1 );
(0.8pHt 1 , 0.8pHt 1 )
(T2) Suppose in t = 2, 3 both …rms charge the same price, but neither …rm
is constrained. Fix a continuation strategy in t + 1. Suppose …rm i
prefers leaving the market in t to j rather than taking the market
(and conversely for j). Then j wins the market.
Example: In Baumol-Game (in period 2), L may want to let H win to
be free to set high prices later
(T3) If …rm H is indi¤erent between entering and not entering given the
subsequent subgame strategies, it will not enter.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
14 / 32
3 Theory
3.3 Laissez Faire plus Brooke
Proposition
The Laissez Faire and Brooke Game both have a unique SPE in pure
strategies without entry and L monopoly prices.
(i) Player L participates in periods 1-4 if he has not exited before.
(ii) H only participates if L has previously exited.
(iii) Monopolists always set their respective monopoly prices
(v) In periods in which both players participate, ptL = ptH = cH ; player L
has a market share of 1.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
15 / 32
3 Theory
3.4 Edlin
Proposition
The Edlin Game has an outcome-unique SPE without entry, in which …rm
L sets the entry-deterring price p except in period 4 (pHL = p m (cL )).
(i) In period 4: If L previously exited or undercut H with p3 < p , only H is
in the market (and sets its monopoly price). Otherwise only L is in the
market and sets the monopoly price.
(ii) In periods 2-3: L deters entry (induces exit) unless restricted to set a
price above p ; H undercuts L if possible; then exits in the next period. L
stays.
Outcome for L-incumbents, depending on 0.8pLt 1 :
L wins
exit
A. Schmutzler (ECON)
cH
H wins
exit
p⇤
H wins
no exit
Experimental evidence on predatory pricing
November 2015
16 / 32
3 Theory
3.5 Baumol
Proposition
The Baumol Game has an SPE without entry in which …rm L sets its
monopoly price.
(i) In periods 3 and 4, monopolists set the monopoly price unless restricted
by the Baumol constraint. When both …rms are in the market, asymmetric
Bertrand equilibrium prices cH = 30 result.
Only L participates unless (a) it previously exited or (b) priced below its
break-even price. With (a), only H participates (provided it can break
even!); with (b), there is a mixed equilibrium with zero expected pro…ts
(ii) In period 2, behavior is similar, except that, in duopolies, there is a
continuum of prices [cH , p
e2 ] [30, 32.679], and H wins.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
17 / 32
3 Theory
3.6 Welfare Benchmarks
Welfare benchmarks
Welfare:
Total surplus
Consumer surplus
Firm profits
1800
1550
1539.8
1250
1248.8
1211.6
1100
628.6
627.7
620.2
583.9
650
450
0
0
-250
Regulated Regulated
MC-Mo.
A. Schmutzler (ECON)
AC-Mo.
Bertrand
Duopoly
Edlin
1-3
Edlin
Laissez-Faire
Brooke, Baumol
1-4
Experimental evidence on predatory pricing
November 2015
18 / 32
4 Experimental Results
4.1 Overview
As expected, in Laissez-Faire and Brooke treatments there is little
entry, high pre-entry and post-exit prices
As expected, Edlin pre-entry prices are lower than in other treatments
As expected, Baumol post-exit prices are lower than in other
treatments
More surprisingly, Edlin encourages entry and yields substantial
incumbent exit
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
19 / 32
4 Experimental Results
4.2 Laissez-Faire Treatment
Overview of Prices:
Pre-Entry 49.6
(Prediction 50)
Post-Entry 34.9
(Prediction 30)
Post-Exit about 50.7
(Prediction 50)
Note: Post-Entry price is just below break-even price
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
20 / 32
4 Experimental Results
4.2 Laissez-Faire Treatment
Entrant
.1
.05
50
>50
40
45
35
30
25
<20
20
50
>50
40
45
35
30
25
<20
20
0
Frequency
.15
.2
Incumbent
Price
Market share:
0%
50%
100%
Figure: Histogram of the incumbents prices in phase PostEntry of treatment
Laissez-Faire.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
21 / 32
4 Experimental Results
4.2 Laissez-Faire Treatment
33% of H …rms never enter (58% in …nal round)
L usually undercuts H
Average Pro…t of H-entrants is -235
Entrants earn positive pro…ts only in 13.4% of the competitive
constellations
61% of H-entrants exit at some point
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
22 / 32
4 Experimental Results
4.2 Laissez-Faire Treatment
Summary:
Monopolistic Pre-Entry Prices
Limited entry
Price war after entry (usually won by L)
Frequent H-exit thereafter
Monopolistic Post-Exit Prices
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
23 / 32
4 Experimental Results
4.3 Policies
PostEntry
PostExit
45
40
30
35
Price incumbent
50
55
PreEntry
1
2
3
4
5
6
7
1
2
3
4
5
6
7
1
2
3
4
5
6
7
Round
LaissezFaire
Brooke
Baumol
Edlin
Figure: Incumbents prices in the three phases and across treatment: Dynamics
across the seven rounds of the experiment.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
24 / 32
4 Experimental Results
4.3 Policies
Stage
1
2
3
4
Table 1: Price of H in PreEntry
LaissezFaire Brooke Baumol
50.11
48.25
49.82
49.84
48.70
49.18
49.91
49.67
50.41
49.70
49.06
49.12
Edlin
47.43
45.08
39.43
45.62
Figure: Price of H in PreEntry
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
25 / 32
4 Experimental Results
4.3 Policies
Period
2
3
4
Table 1: Price of H in PostEntry
LaissezFaire Brooke Baumol
35.55
34.48
34.09
37.22
32.67
33.81
37.56
35.13
36.71
Edlin
39.83
34.55
31.72
Figure: Price of H in PostEntry
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
26 / 32
4 Experimental Results
4.3 Policies
Table 1: Price of H in PostEntry
Period LaissezFaire Brooke Baumol
2
3
4
51.54
50.31
50.00
49.45
38.42
38.84
Edlin
50.00
49.93
Figure: Price of H in PostEntry
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
27 / 32
4 Experimental Results
4.3 Policies
Pricing: Summary
Pre-Entry Prices:
around monopoly price for LF, Brooke, Baumol
Lower (average 46.2) for Edlin; in particular in rounds 4-7
Post-Entry Prices:
Much lower than pre-entry
Similar across treatments
Post-Exit Prices:
around monopoly price for LF, Brooke, Edlin
Lower (average 38.7) for Baumol; in particular in rounds 4-7
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
28 / 32
4 Experimental Results
4.3 Policies
Brooke
0
1
2
3
4
5
6
7
1
2
3
Baumol
4
5
6
7
5
6
7
Edlin
Incumbent exit
Entry & stay
Entry & exit
No entry
0
.2
.4
.6
.8
1
Fraction
.2
.4
.6
.8
1
LaissezFaire
1
2
3
4
5
6
7
1
2
3
4
Round
Figure: Incumbents prices in the three phases and across treatment: Dynamics
across the seven rounds of the experiment.
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
29 / 32
4 Experimental Results
4.3 Policies
Participation: Summary
(Focus on periods 4-7)
No entry is common in LAISSEZ FAIRE, BROOKE
No entry is less frequent in BAUMOL, very infrequent in EDLIN
In all treatments, a large fraction of entrants exits again
There is a surprising amount of ine¢ cient and probably irrational
incumbent exit
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
30 / 32
5 Conclusion
5.1 Summary of Good News
If we take this exercise seriously . . . . We have caught the unicorn!
When there are no relevant pricing restrictions
(apparent) fear of above-cost predatory pricing discourages entry
Post-entry price wars induce exit
Post-exit prices return to monopoly level
With post-entry pricing restrictions (Edlin)
There is more entry
Pre-entry prices decline
With post-exit pricing restrictions (Baumol)
There is an intermediate amount of entry
Post-exit prices decline
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
31 / 32
5 Conclusion
5.1 Summary
Discussion
In all treatments, there is substantial entry - experimental artefact?
In Edlin treatments, entry is extremely strong. Why?
In Edlin treatments, there is substantial incumbent exit. Why?
Post-entry behavior is quite similar – no di¤erences in predation?
A. Schmutzler (ECON)
Experimental evidence on predatory pricing
November 2015
32 / 32