On the Rationality of Limit Pricing

THE theory of limit pricing had its genesis in a suggestion of Harrod's (I952) that firms in monopolistically competitive markets might not reach the 'tangency solution' of Chamberlin (with its implied excess capacity) but might rather set a price lower than the tangency price, so as to discourage the entrance of new competitors.' This suggestion was later adopted by Bain (1956) and Sylos-Labini (I957) and made into the key feature of a theory of oligopoly price. The independent contributions of Bain and Sylos-Labini were reviewed, synthesized, and extended by Modigliani (i 958). The result promises to become a standard part of the apparatus which serves in place of a theory of oligopoly. It appears, for example, as a basic element in the recent study of Dewey's (i969) and is given more than passing attention by Scherer (1970). Moreover, the theory has recently been examined in a dynamic setting by Wenders (I97i) and Kamien and Schwartz (I97I). This dynamic extension is a perfectly natural development, as the problem of entry and what to do about it is, from the standpoint of established firms, inherently dynamic. Entry takes time. However, while it is true that a dynamic formulation is bound to be more satisfactory than a static one, a complete understanding of the theory's static properties is necessary for its proper development. This note is directed toward that end.