hunting unicorns? experimental evidence on predatory...
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Hunting unicorns? Experimental evidence on predatorypricing 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 Introduction1.1 Overview
Previous legal and economic literature has debated whetherbelow-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 highprices
We investigate whether standard and non-standard policies againstpredatory pricing can help
We provide experimental evidence confirming some aspects of theory(and leaving some puzzles)
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1 Introduction1.2 Below-cost predatory pricing
Below-cost predatory pricing: Setting prices below costs with the goalof inducing exit or preventing entry in order to increase profits in thelong term
Several legal cases have dealt with the phenomenon
Chicago arguments have been put forward against it: with symmetricfirms, it is hard to recoup the short-term profit losses
Game theoretic arguments can support the idea: long purse, signaling,repeated games
Real-world evidence is rare
Experimental evidence is mixed
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1 Introduction1.2 Below-cost predatory pricing
Are there so many theories of predation because it “is a common butvariegated phenomenon”or rather “for the same reason that 600 yearsago there were a thousand positions on what dragons looked like”?
“There is no suffi 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 inGoeree et al., 2004)
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1 Introduction1.3 Above-cost predatory pricing
Idea (Edlin 2001):
An effi cient firm that faces an ineffi cient potential entrant cancredibly 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, eventhough 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 thisbehaviorBaumol Rule requires keeping prices low post exit: does not attractentry
Edlin Rule requires not lowering price too much after entry: Can thisinduce entry and/or reduce prices?
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 5 / 32
1 Introduction1.3 Above-cost predatory pricing
Basic empirical challenge:
If entrants do not enter for fear of predatory pricing, above-costpredatory pricing may have an effect without ever being observed
But if we see "insuffi cient entry" in the field, when can we attributethis to fear of above-cost predatory pricing?
It would be necessary to compare entry in a laissez-faire environmentand one where above-cost predatory pricing is diffi cult for legalreasons.
But how? —> Lab experiment
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1 Introduction1.4 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 off-equilibrium event caninfluence decisions
Allow for policy experimentation under similar conditions
Understand how players choose between various “somewhat rationalalternatives”
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 7 / 32
1 Introduction1.5 This paper
Theory:
In the SPE of finitely repeated versions of "above-cost predatorypricing games" there is no entry along the equilibrium path:
trivial with Laissez-Faire and Brooke rulemessy 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 Introduction1.6 Overview
1 Introduction2 Experimental Set-Up3 Theory4 Experimental Results5 Discussion
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2 Experimental Set-Up2.1 Overview
four treatments: LAISSEZ-FAIRE, BROOKE, EDLIN, BAUMOL
seven rounds per treatment, each consisting of a four-period game
two firms L and H with marginal costs cL < cH can produce ahomogenous good with demand D(p)
in stage 1, firm L decides whether to incur fixed costs F ofproduction, sets price thereafter
in stages 2-4, both firms simultaneously decide on participation, thensimultaneously choose prices
exit is irreversible
perfect information
no financial constraints
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 10 / 32
2 Experimental Set-Up2.2 Treatments
DefinitionAn incumbent in period t is a firm that had a market share of one inperiod t − 1 and is present in period t
LAISSEZ-FAIRE: No restrictions on prices.
BROOKE: An incumbent is not allowed to price below its ownmarginal cost in duopoly periods.
EDLIN: An incumbent is not allowed to price below η times itsprevious price (η ∈ (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 anylater period.
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 11 / 32
2 Experimental Set-Up2.3 Parameters
D(p) = 80− pPrice space: [0, 80]
cH = 30
cL = 20
F = 250
η = 0.8
Moreover:
Firms with equal prices share the market
Without entry, firms earn 50. Entry costs 200.
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3 Theory3.1 Overview of Critical Prices
pBH , pBL : break-even prices
pM (cH ), pM (cL): monopoly prices
p∗ such that 0.8p∗ = pBL : entry-deterring price (Edlin)
Overview of Prices
0
cL
20
pBL
24.5
cH
30
pBH
35.6
p⇤
44.5
pM (cL)
50
pM (cH)
55 80
1
Note: pBL < cH ; p∗ < pM (cL)
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3 Theory3.2 Tie-Breaking
(T1) In any situation where both firms charge the same price, but aprofitable short-term downward deviation for exactly one firm isfeasible, this firm wins the entire market (and becomes the incumbentin the next period).Examples: (ptL, p
tH ) = (cH ,cH ); (0.8p
t−1L , 0.8pt−1L );
(0.8pt−1H , 0.8pt−1H )
(T2) Suppose in t = 2, 3 both firms charge the same price, but neither firmis constrained. Fix a continuation strategy in t + 1. Suppose firm iprefers 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 tobe free to set high prices later
(T3) If firm H is indifferent between entering and not entering given thesubsequent subgame strategies, it will not enter.
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 14 / 32
3 Theory3.3 Laissez Faire plus Brooke
PropositionThe Laissez Faire and Brooke Game both have a unique SPE in purestrategies 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, pLt = p
Ht = cH ; player L
has a market share of 1.
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 15 / 32
3 Theory3.4 Edlin
PropositionThe Edlin Game has an outcome-unique SPE without entry, in which firmL sets the entry-deterring price p∗ except in period 4 (pLH = p
m(cL)).(i) In period 4: If L previously exited or undercut H with p3 < p∗, only H isin the market (and sets its monopoly price). Otherwise only L is in themarket and sets the monopoly price.(ii) In periods 2-3: L deters entry (induces exit) unless restricted to set aprice above p∗; H undercuts L if possible; then exits in the next period. Lstays.
Outcome for L-incumbents, depending on 0.8pLt�1:
cH p⇤
L winsexit
H winsexit
H winsno exit
1
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 16 / 32
3 Theory3.5 Baumol
PropositionThe Baumol Game has an SPE without entry in which firm L sets itsmonopoly price.
(i) In periods 3 and 4, monopolists set the monopoly price unless restrictedby the Baumol constraint. When both firms are in the market, asymmetricBertrand equilibrium prices cH = 30 result.Only L participates unless (a) it previously exited or (b) priced below itsbreak-even price. With (a), only H participates (provided it can breakeven!); with (b), there is a mixed equilibrium with zero expected profits(ii) In period 2, behavior is similar, except that, in duopolies, there is acontinuum of prices [cH , p̃2] ≈ [30, 32.679], and H wins.
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 17 / 32
3 Theory3.6 Welfare Benchmarks
Welfare benchmarksWelfare:
Total surplus
Consumer surplus
Firm profits
1800
1550
-250
Regulated
MC-Mo.
1539.8
0
Regulated
AC-Mo.
0
1250
Bertrand
Duopoly
1248.8
628.6
620.2
Edlin
1-3
1211.6
583.9
627.7
Edlin
1-4
1100
650
450
Laissez-Faire
Brooke, Baumol
1
Figure:A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 18 / 32
4 Experimental Results4.1 Overview
As expected, in Laissez-Faire and Brooke treatments there is littleentry, 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 othertreatments
More surprisingly, Edlin encourages entry and yields substantialincumbent exit
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4 Experimental Results4.2 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
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4 Experimental Results4.2 Laissez-Faire Treatment
0.0
5.1
.15
.2
<20 20 25 30 35 40 45 50
>50
<20 20 25 30 35 40 45 50
>50
Incumbent Entrant
Market share: 0% 50% 100%
Fre
quen
cy
Price
Figure: Histogram of the incumbents prices in phase PostEntry of treatmentLaissez-Faire.
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4 Experimental Results4.2 Laissez-Faire Treatment
33% of H firms never enter (58% in final round)
L usually undercuts H
Average Profit of H-entrants is -235
Entrants earn positive profits only in 13.4% of the competitiveconstellations
61% of H-entrants exit at some point
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4 Experimental Results4.2 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
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4 Experimental Results4.3 Policies
30
35
40
45
50
55
1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7
PreEntry PostEntry PostExit
LaissezFaire
Brooke
Baumol
Edlin
Pri
ce incu
mben
t
Round
Figure: Incumbents prices in the three phases and across treatment: Dynamicsacross the seven rounds of the experiment.
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4 Experimental Results4.3 Policies
Table 1: Price of H in PreEntry
Stage LaissezFaire Brooke Baumol Edlin
1 50.11 48.70 50.41 47.432 48.25 49.18 49.70 45.083 49.82 49.91 49.06 39.434 49.84 49.67 49.12 45.62
1
Figure: Price of H in PreEntry
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4 Experimental Results4.3 Policies
Table 1: Price of H in PostEntry
Period LaissezFaire Brooke Baumol Edlin
2 35.55 37.22 37.56 39.833 34.48 32.67 35.13 34.554 34.09 33.81 36.71 31.72
1
Figure: Price of H in PostEntry
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4 Experimental Results4.3 Policies
Table 1: Price of H in PostEntry
Period LaissezFaire Brooke Baumol Edlin
23 51.54 50.00 38.42 50.004 50.31 49.45 38.84 49.93
1
Figure: Price of H in PostEntry
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4 Experimental Results4.3 Policies
Pricing: Summary
Pre-Entry Prices:
around monopoly price for LF, Brooke, BaumolLower (average 46.2) for Edlin; in particular in rounds 4-7
Post-Entry Prices:
Much lower than pre-entrySimilar across treatments
Post-Exit Prices:
around monopoly price for LF, Brooke, EdlinLower (average 38.7) for Baumol; in particular in rounds 4-7
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4 Experimental Results4.3 Policies
0.2
.4.6
.81
0.2
.4.6
.81
1 2 3 4 5 6 7 1 2 3 4 5 6 7
1 2 3 4 5 6 7 1 2 3 4 5 6 7
LaissezFaire Brooke
Baumol Edlin
Incumbent exit
Entry & stay
Entry & exit
No entry
Fra
ctio
n
Round
Figure: Incumbents prices in the three phases and across treatment: Dynamicsacross the seven rounds of the experiment.
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4 Experimental Results4.3 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 ineffi cient and probably irrationalincumbent exit
A. Schmutzler (ECON) Experimental evidence on predatory pricing November 2015 30 / 32
5 Conclusion5.1 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 entryPost-entry price wars induce exitPost-exit prices return to monopoly level
With post-entry pricing restrictions (Edlin)
There is more entryPre-entry prices decline
With post-exit pricing restrictions (Baumol)
There is an intermediate amount of entryPost-exit prices decline
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5 Conclusion5.1 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 differences in predation?
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