An Empirical & Theoretical Comparison of Alternative Predation Rules

An Empirical & Theoretical Comparison of Alternative Predation Rules

By Richard O. Zerbe (University of Washington) & Donald Cooper

Many lawyers and economists use economic theory and limited empirical analysis to justify particular rules against predatory pricing. Their various proposals range from no rule at all to a rule that would restrict production. However, as this Article demonstrates, economic theory alone simply cannot provide unequivocal justification for any rule.

This Article combines economic theory with empirical review. After defining predatory pricing in part II, it turns in part III to the development of the first relatively complete welfare analysis of predatory pricing. Part IV suggests that the best rule against predation is a rule that prohibits pricing below either average total cost (when production is on the rising portion of the average total cost curve) or below average variable cost (at all other production levels).

Parts V and VI confirm these theoretical results by empirically the welfare effects of its proposed rule against other proposals. Five rules are tested: (1) the Areeda-Turner cost-based rule which defines predation as pricing below average variable costs; (2) the Williamson output limitation rule which prevents a dominant firm from increasing output for eighteen months after entry; (3) the Joskow-Klevorick rules which prohibit predation only when certain market and firm structural conditions are met; (4) the Bork-Easterbrook per se legal rule under which predation is legal; and (5) a modified Areeda-Turner rule which prohibits price cuts that lower price below either average total cost or average variable cost, depending on production level. The empirical results confirm the predicted theoretical results.

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