Limit price

The problem with limit pricing as strategic behavior is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response.

This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible.

A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not.

An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time.

Due to the often ambiguous nature of cost in production, it may be relatively easy for a firm to avoid legal difficulties when undertaking such action.

Due to this ambiguous nature, limit pricing may well be a commonly used strategy even in modern economies.

However, it is often very hard to regulate, since limit pricing is often synonymous with a market monopoly.

That is, the market for good X is an effective monopoly if: Suppose, on the contrary, that: In this case, if Firm A charges

To maximize its profits subject to this constraint, Firm A sets price