Okay, I'm having a discussion with a socialist/statist about the free market, monopoly, and anti-trust laws (repeal them!). I'm getting to the point where my austro-libertarian knowledge is incomplete. He says:
It is a major financial commitment for a startup to stock and staff a store. As soon as they do, bang! Down the prices go down the street!
Is it "peaceful" to attack competitors with your superior economic strength?
If you think it is, then you must agree with my contention that free markets will always end up with a very few dominant players is correct, because that is the inevitable result.
Do you think that the best interests of society are served when a dominant business can dictate prices and drive out competitors?
How do I respond to this?
Matthew:How do I respond to this?
He's talking about "predatory pricing." It's true he has no understanding of business, entrepreneurship or economics. Send him a copy of the rest of this post:
People will say things like "once they've got a foothold in a community, what's to stop them from raising their prices, too? Absolutely nothing."
That's why this old and popular myth of economics is known as "predatory pricing." Sounds scary right? You know this one. It's basically the idea that a big firm that can afford to sell products at a loss for a while (i.e. for less than they paid for them) will drop their prices so low that smaller firms will be driven out of business. After the competition has been forced out of the market, the predatory firm raises its price, compensating itself for the money it lost while it was engaged in predatory pricing, and earns monopoly profits forever after.
Sounds logical right? The problem with this is, it doesn't work economically...and (therefore as you would expect) there are virtually no examples of this occurring. There has never been a single clear-cut example of a monopoly created by so-called predatory pricing, let alone one in which prices were raised drastically and customers were "gouged." Claims of predatory pricing are typically made by competitors who are either unwilling or unable to cut their own prices. And as I stated, this is not just a situation in which we have no examples...it economically doesn't work...and has been shown for decades to not work.
Here's a short video that tells a really great story of when a big firm tried predatory pricing against a very smart fellow whose name you've probably heard of.
For anyone interested in the actual economics of the theory, I've provided several resources below, some of which actually contain references to dozens more. But for the Cliff's Notes kids, I'll just offer some highlights just for those interested (my comments are in italics in the brackets):
And he actually goes on and on. Another big one is the concept of brand reputation. If every time a new competitor pops up, you drop your prices to compete, and then the competitor disappears, and you jack up your prices, how long will it take before people just won't shop at your store? There is a lot to be said for reputation and brand loyalty. If the choice is between a new place that is giving good service and reasonable prices that stay reasonable, people will choose that over a quixotic price changer pretty darn quick.
If you're interested in more reasons why it never works, I highly recommend following the links to sources #1 and #3. Reisman goes into great detail, but provides very simple, easy to understand examples.
1 - DiLorenzo, Thomas J. 1992. “The Myth of Predatory Pricing,” Policy Analysis No. 169. Cato Institute; http://mx.nthu.edu.tw/~cshwang/teach...03-06-monopoly and profit/DiLorenzo=THE MYTH OF PREDATORY PRICING.pdf
2 - Anderson, William L. 2003. "Pounding Square Pegs into Round Holes: Another Look at the Neo-Classical Theory of Predatory Pricing." The Quarterly Journal of Austrian Economics, Vol. 6, Spring; http://mises.org/journals/qjae/pdf/qjae6_1_2.pdf
3 - Reisman, George. 1998. Capitalism: A Treatise on Economics. Ottawa, IL: Jameson Books. pp. 399-407; http://www.capitalism.net/Capitalism...M_Internet.pdf
4 - http://mises.org/daily/226
5 - Isaac, R. Mark, and Vernon L. Smith. 1985. “In Search of Predatory Pricing.” Journal of Political Economy 93: 320–45.
Here's the tl;dr version - the notion of "predatory pricing" is one great big appeal to fear.
The keyboard is mightier than the gun.
Non parit potestas ipsius auctoritatem.
I'll copy and paste my response to a socialist about predatory pricing aswell if it helps. It's just a concatenation of all the posts I've read on here.
The people who make these arguments imagine a static pool of competitors. If there are 3 grocery stores in a given area, and Company P (Predator), drives out their two competitors, companies A and B... Then begins to charge "predatory pricing", either companies from other areas/countries can move in, or even companies from completely different fields.
If company P lowers prices below cost and can outlast company B and cause company B to go out of business, company P will have to charge super-normal prices to recoup the losses from the "predatory pricing" strategy. But when company B goes out of business the factory and personel with expertise don't simply fade into the dust, they can be purchased and could easily compete with company P if it is charging prices that are too high.
Also the whole story of predatory pricing leaves out potential competitors and only takes into account current competitors. If I knew that company P was going to raise prices after company B went out of business I would open company C and would easily be able to out compete company P, because they will have to charge very high prices because of all the money they lost putting company B out of business. Even the THREAT of an outside competitor entering the market is enough to keep the price lower.
Companies A and B can buy as much inventory as they can from Company P (since they are selling below cost), and then sell it for slightly higher. Each product A and B buys drives Company P more into the red. It is again, unsustainable.
If one company decides to undercut another with predatory pricing, the other company can just wait it out and tell its investors what's happening. The company that does the undercutting is hurting its own profits more than the competitor's, after all, the undercutter is attracting demand to a product its losing money on, while the competition keeps prices at profitable levels. At most, the undercutter can hope for a short-run increase in market share which will disappear as soon as the undercutter raises prices back to normal levels.
There is nothing wrong with predatory pricing anyway. If a compnay is selling its product below production cost, then the consumer gains by getting something for free. If it made its prices real high after destroying the competition, new competitors would enter the market again to get a piece of the profitable market. And the company would have to lower prices again below cost of production.. and again the consumer would benifit. You see, it just does not make business sense to make a loss selling below producton cost just to be able to make profit later.. because the company would always be atacked by new competitors undercutting its high prices, there would always be another company that had to be starved to death.. and in the meantime consumers would be getting stuff for free. Noone ever got rich giving stuff away for free.. and if some company is giving away something for free.. we as consumers should be thankful that this company is so foolish. Unless you use the government to make your competition illegal
$10 drug now $1500 after FDA grants monopoly http://www.boingboing.net/2011/03/14/10-drug-becomes-1500.html
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Jack Roberts:So not necessarily "big business" but just improved production, distribution and logistics, this can cause a reduction in cost without any loss in quality. For the consumer cheaper prices and better products is a good thing, but it does happen in today’s society and people do lose their businesses.
Is there some society you know of where businesses don't go out of business?
EmperorNero:here comes my question, competitors know that once they compete with him there will be a price war and not a lot of profit to be had, won't that act as a barrier to entry?
It sounds like you're saying that once one company starts selling a good or service—"first mover advantage" is not a business term for no reason—and they therefore have a "natural edge" over any competition that might arise, no other firm would wish to compete with them because there would be a "price war." Do you have any evidence for this? Because reality would seem to disagree with you.
also, just as there are economies of scale, there are also diseconomies of scale, which put natural limits on firm size. Natural limits which can only be overcome with the help of the state. Big firms also run into the same knowledge problem that plagues central planners. If its too vertical, the firm will be too slow to react to changes in the market.