Bain’s limit pricing model

Oligopoly pricing, limit pricing,

1. BAIN’S LIMIT PRICING
MODEL
Prof. Prabha Panth,
Osmania University,
Hyderabad

2. Limit pricing
•Traditional theory only discusses actual entry,
not potential entry of new firms. This leads to
normal profits in the long run in perfect and
monopolistic competition.
•According to Bain:
Firms do not maximiseprofits in the short run
due to fear of potential entry of new firms
attracted by the maximum profits.
This will reduce their long run profits.
2Prabha Panth

3. Limit pricing
So Oligopoly firms fix a P that does not maximise
their revenue, i.e. P is fixed on the Inelastic
part of D-curve.
•Limit Price: highest price that existing firms
charge without fear of attracting new firms.
“Entry preventing” price, acts as barrier to
entry of new firms.
3Prabha Panth

4. •Assumptions:
1.There is a determinate long run industry D-curve,
2.Collusion among existing oligopoly firms,
3.Limit pricing. Price set depends on:
a.Estimated costs of potential entry,
b.Market elasticity of D,
c.Shape and level of LAC (constant costs)
d.Size of the market,
e.Number of firms in the industry
4. Established firms seek long run profits.
5. Uncertainty above the limit price, as new firms
enter.
Prabha Panth 4

5. C, R
0
Pm
Q
B
A
PL
Pc
QmQ1
QLQc
D = AR
MR
C
C1m
Figure 1
LACp= LMCp
LACc= LMCc

6. Prabha Panth 6
In figure 1:
•Downward sloping AR, MR curves.
•Constant cost industry, LAC is horizontal straight line.
LAC = LMC
1)PC firm: P = oPc.Equilibrium at B, Q= Qc. Normal
profits as AR = LACc.
2)Monopoly firm: P = Pm. Equilibrium at m, MC=MR,
MC. Q = Qm. Abnormal profits = PcPmAm.
3)Limit Price firm: price fixed at Pl > Pc, but < Pm.
Point of entry of potential firms. Abnormal profits =
PcPlCC1 < Monopoly profits, but > perfect
competition.

7. •Monopoly price is fixed at the elastic part of
the demand curve.
•Monopoly firm makes large abnormal profits.
•This attracts new firms, and monopoly loses
its market. Area of uncertainty.
•If firms fix a price < Pm but > Pc,
•They still earn some abnormal profits, but not
maximum profits.
Prabha Panth 7

8. •At this price, D curve is inelastic, i.e. MR
<0.
•Prevents new entry, as at this price, new
firms make only normal profits.
•Oligopoly market remains stable.
Prabha Panth 8