Economics of Predation

Donald Boudreaux, Director of the Foundation for Economic Education, in Irvington-on-Hudson, New York and John T. Wenders, Professor of Economics at the University of Idaho wrote articles in the September 1998 issue and December 1988 issue of the Washington, D.C.-based Competitive Enterprise Institute's monthly "Update" about predation. Predatory pricing is the practice of cutting your prices so low as to bankrupt your competition. Afterwards the predator raises his prices and earns monopoly profits. Today's suspects include Microsoft and major U.S. airlines. Despite the claims of the U.S. Justice Department's Antitrust Division, predatory pricing is not effective and will not likely be used as a means to monopoly power. Let's look at it, pretending that a company like Sears is trying to run its competitors out of the market.

Suppose Sears targets K-Mart and other retailers for predation by lowering its prices below costs. The first fact is that the predator must lose more money than any of its prey and the bigger the predator, the bigger will be its losses. Second, the prey is not helpless in the wake of predation; it has several strategies. One is to temporarily shut down and allow the predator to take the losses from charging low prices. Donald Boudreaux says if the prey is an efficient producer, he can borrow money to weather the attack. Professor Wenders brings the element of time into the picture, pointing out that the predator is trading up-front losses for discounted future revenues. In other words, a dollar's worth of revenue lost today by charging low prices will have to bring in more than two dollars four or five years from now to make it worth while. Thus, to recoup today's losses, the predator will have to charge very high prices in the future and that will invite new entrants.

Finally, suppose in our example Sears was successful in bankrupting K-Mart. Bankruptcy does not mean productive assets go poof and disappear into thin air. Bankruptcy simply means that the title to those productive assets have changed - there is a new owner. Since the new owner purchases the assets at bargain basement prices, he will be in a better position to fight predation.

A historical tidbit points to another anti-predation strategy. Robert Gordon, a slave, purchased his freedom and moved to Cincinnati where he invested $1,500 in a coal yard and a private dock on the waterfront. White competitors tried to run him out of business through ruthless price-cutting. Gordon simply hired fair-complexioned mulattoes to purchase coal from his price-cutting competitors to fill his own customer's orders.

The fact that market forces make predation a highly unsuccessful means to gain unlikely monopoly power is not the same as saying there are not anti-competitive practices that restrict competition. Most anti-competitive practices have their roots in federal, state and local laws that forestall entry and set minimum prices. Among the many examples are the U.S. Department of Commerce "marketing orders" that allow growers to collude to restrict the supply of fruits and vegetables. U.S. sugar and peanut producers make campaign contributions to get congressmen to restrict imports so they can charge higher prices. Many cities restrict the number of taxicabs so that those who are already in can charge higher prices. Real estate brokers can lose their licenses, or access to trade tools such as the multiple-listing, for engaging in "unethical practices" (read: charging too low a commission).

If we're really concerned about uncompetitive practices, we should look at legalized collusions. After all, why is it that corporations give millions of dollars to elected officials? Do you think it's simply public-spirited behavior?

Walter E. Williams


December 22, 1998

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