Source: https://fr.b-ok.org/book/2797697/717152
Timestamp: 2020-02-23 18:13:19
Document Index: 393843380

Matched Legal Cases: ['§1', '§2', '§3', '§4', '§5', '§6', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§8', '§9', '§1', '§2', '§3', '§4', '§5', '§6', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§8', '§9', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§8', '§9', '§10', '§11', '§1', '§2', '§3', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§8', '§9', '§1', '§2', '§3', '§4', '§5', '§6', '§7', '§8', '§1', '§2', '§3', '§4', '§2', '§2', '§2', '§2', '§2', '§2', '§13', '§3', '§2', '§2', '§2']

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Scott Gilbert (auth.)
Sylvie Hancil, Alexander Haselow, Margje Post (eds.)
Predatory Pricing in Antitrust Law
Can a price ever be too low? Can competition ever be ruinous? Questions like
these have always accompanied American antitrust law. They testify to the difficulty of antitrust enforcement, of protecting competition without protecting
As the business practice that most directly raises these kinds of questions,
predatory pricing is at the core of antitrust debates. The history of its law and
economics offers a privileged standpoint for assessing the broader development
of antitrust, its past, present and future. In contrast to existing literature, this
book adopts the perspective of the history of economic thought to tell this
history, covering a period from the late 1880s to present times.
The image of a big firm, such as Rockefeller’s Standard Oil or Duke’s American Tobacco, crushing its small rivals by underselling them is iconic in American antitrust culture. It is no surprise that the most brilliant legal and economic
minds of the last 130 years have been engaged in solving the predatory pricing
puzzle. The book shows economic theories that build rigorous stories explaining
when predatory pricing may be rational, what welfare harm it may cause and
how the law may fight it. Among these narratives, a special place belongs to the
Chicago story, according to which predatory pricing is never profitable and
every low price is always a good price.
Nicola Giocoli is an Associate Professor of Economics at the University of Pisa,
1 Compensation for Regulatory Takings
3 The Law and Economics of Development
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4 Fundamental Interrelationships Between Government and Property
5 Property Rights, Economics, and the Environment
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7 The End of Natural Monopoly
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Effects in a national and international framework
16 The Applied Law and Economics of Public Procurement
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Edited by Yun-­chien Chang
20 Predatory Pricing in Antitrust Law and Economics
* The first three volumes listed above are published by and available from
Predatory Pricing in Antitrust
© 2014 Nicola Giocoli
The right of Nicola Giocoli to be identified as author of this work has been
ISBN: 978-0-415-82252-7 (hbk)
ISBN: 978-1-315-83269-2 (ebk)
To Ninetta and the four cousins Enzo, Maria, Rita and
In our worship of the survival of the fit under free natural selection we are sometimes in danger of forgetting that the conditions of the struggle fix the kind of
fitness that shall come out of it; that survival in the prize ring means fitness for
pugilism; not for bricklaying nor philanthropy; that survival in predatory competition is likely to mean something else than fitness for good and efficient production; and that only from a strife with the right kind of rules can the right kind
of fitness emerge. Competition and its purpose are not individual but social. It is
a game played under rules fixed by the state to the end that, so far as possible, the
prize of victory shall be earned, not by trickery or mere self-­seeking adroitness,
but by value rendered. It is not the mere play of unrestrained self-­interest; it is a
method of harnessing the wild beast of self-­interest to serve the common good –
a thing of ideals and not of sordidness. It is not a natural state, but like any other
form of liberty, it is a social achievement, and eternal vigilance is the price of it.
(Clark and Clark [1912] 1914, 200–1)
Highly speculative belief about behavior or its consequences does not satisfy [the
legal] standard, even when endorsed by expert economic witnesses.
(Demsetz 1992, 209–10)
It would be indeed an extraordinary thing to strike at competition in the name of
(Macrosty 1907, 345)
§1 Three basic dichotomies 1
§2 The trickiest antitrust problem 3
§3 Further reasons to love predation 5
§4 Lessons in persuasion 8
§5 Treasures in the attic 9
§6 Plan of the book 11
The economics of predatory pricing
§1 Classic and modern definitions of predatory pricing 13
§2 The basic story 19
§3 The Chicago critique of the basic story 22
§4 It’s a brand new game: predation as strategic
§5 The Stanford connection 28
§6 Madamina, il catalogo è questo 35
§7 Assessing the Bayesian approach to predation 42
The two freedoms and British common law
§1 The two freedoms 49
§2 The monopoly problem in British common law 50
§3 The classical view of competition 54
§4 Competition in the late nineteenth-­century British
§5 The dawn of predatory pricing: the Mogul case 60
§6 The Mogul decisions: is predation “a matter contrary to
law”? 62
§7 The new reasonableness test: the Nordenfelt case 66
§8 The legacy of Mogul and Nordenfelt 69
§9 Restraints of trade in American common law 73
American economists and destructive competition
§1 Monopoly as the inevitable outcome of competition 81
§2 “Let us have peace”: the combination way-­out 83
§3 From destructive competition to predatory pricing 86
§4 Economic power and the curse of bigness 88
§5 Playing the trump card: potential competition 90
§6 From Clark to Clarks 94
Predatory pricing in the formative era of antitrust law
§1 Constitutionalizing freedom of contract 103
§2 The two views in action: the Sherman Act’s Congressional
§3 Transcending common law: monopolizing and third-­party
actionability 109
§4 The economists’ reaction to the Sherman Act 110
§5 Common law, literalism and reasonableness 112
§6 The predatory side of the 1911 cases 120
§7 The economists’ reasonable dissent 125
§8 The Clayton and FTC Acts 127
§9 Predatory pricing in the formative era: an assessment 130
Predatory pricing in the structuralist era
§1 The decades of neglect (1918–35) 135
§2 Competition strikes back: the end of associationalism 138
§3 The structuralist paradigm 140
§4 Mason’s SCP manifesto 142
§5 Extreme structuralism versus workable competition 145
§6 A “new” Sherman Act? 149
§7 The return of Old Sherman 156
§8 The horror list 160
§9 Intent to exclude intent 163
§10 The worst antitrust decision ever? 166
§11 Conclusion: the divorce between antitrust and
The Chicago School and the irrelevance of predation
§1 The dissolution proposals 176
§2 Chicago to the rescue 179
§3 The two Chicagos 181
Listen to McGee: predation doesn’t exist! 187
Chicago’s peculiar methodology 191
Three Chicago boys 193
Conclusion: a new Chicago story 202
Harvard rules: Areeda and Turner’s solution
§1 Two reactions to McGee 210
§2 Strategic predation without game theory 211
§3 From the “wilds of economic theory” . . . 215
§4 . . . to a “meaningful and workable” rule 217
§5 A new legal standard 220
§6 The courts’ reaction to the ATR 223
§7 The economists’ reaction to the ATR 226
§8 The post-­ATR debate in courts 235
§9 Conclusion: lessons from the ATR saga 237
The demise of predatory pricing as an antitrust violation
§1 Mr. Justice goes to Chicago 245
§2 Predatory pricing case law meets Chicago antitrust 248
§3 Predatory pricing’s last cigarette 253
§4 The Brooke test – Chicago creed or apostasy? 255
§5 Administrability is key 259
§6 Price theory no more: a game-­theoretic alternative to
Brooke 263
§7 “An almost interminable series of special cases” 268
§8 Conclusion: Daubert nails in the Post-­Chicago coffin 271
§1 Star Wars without Darth Vader 278
§2 It’s the ideology, stupid! 280
§3 Games judges don’t play 284
§4 Chicago rule(s) 285
List of cases
This volume is part of a broader research project on the history of American
antitrust law and economics. Along the years I have benefited from the comments and help of several colleagues. Without involving them in any responsibility for remaining mistakes, I wish to thank Robert Albon, David Andrews, Jeff
Biddle, Ivars Brivers, Chris Colvin, Carlo Cristiano, Marco Dardi, Luca Fiorito,
Salar Ghahramani, Francesco Guala, Dan Hammond, Herrade Igersheim, Bruna
Ingrao, Andrew Jewett, Albert Jolink, Robin Paul Malloy, Alain Marciano, Steve
Medema, Maurizio Mistri, Ivan Moscati, Lorenzo Pace, Sylvie Rivot, Rodolfo
Signorino, Rob Van Horn, Joshua Wright, Alberto Zanni and the editors and
anonymous referees of the journals where parts of the book have been published
before. I am especially grateful to Tony Freyer (our Harvard meeting shows it’s
a small world – really!), Robert Lande, Andrea Maneschi, Henry Manne, Robert
T. Masson and Jim Rhodes, who gave me additional suggestions and valuable
Portions of the book have appeared elsewhere. Chapter 2 follows in part
Giocoli (2013a); sections of Chapters 6 and 7 are based on Giocoli (2011);
Chapter 8 and Conclusion draw on Giocoli (2013b). I am grateful to the editors
and publishers of, respectively, the Research in the History of Economic Thought
and Methodology (Emerald Group Publishing), the European Journal of the
History of Economic Thought (Routledge, Taylor & Francis Group) and the
Supreme Court Economic Review (University of Chicago Press) for granting
permission to reproduce parts of these papers.
Librarians at the Historical and Special Collections of Harvard Law School
Library were extremely helpful in assisting me while doing archival research on
Areeda, Phillip E., 1930–1995. Papers, 1927–1995. I thank them all – in particular Leslie Schoenfeld, whose kindness and smile did a lot to warm the atmosphere in the HSC room (it does need warming, trust me). I am also grateful to
Ed Moloy for granting permission to quote excerpts from Areeda’s collection.
The Routledge editorial team, past and present, gave me assistance and
encouragement. I thank Rob Langham, Emily Kindleysides, Simon Holt and
Andy Humphrys.
Last, but not least, my collaborators. Domenico Fanelli, Tiziana Foresti,
and, especially, Francesco Cattabrini offered precious research and teaching
Acknowledgments   xiii
assistantship. My deepest gratitude to all of them. Simon Cook did an incredible
job in polishing my English – and beyond. I have no words to express my admiration for someone who combines editorial skills, historical knowledge, good
humor and enduring patience at such a high level. He trespassed the duties
which belong to an editorial assistant (sorry, Simon, I couldn’t resist).
My research benefited from generous financial support by the INET (Institute
for New Economic Thinking). INET grant #5190, awarded to the project “Free
from what? Evolving notions of ‘market freedom’ in the history and contemporary practice of US antitrust law and economics,” is gratefully
The book is dedicated to the loving memory of my parents, Benedetta and
Vincenzo, my aunts, Maria and Rita, and my uncle Enzo, for what they taught
1 Three basic dichotomies
Antitrust law is about competition. It aims at guaranteeing economic agents’
freedom to compete as the best way to promote maximum social welfare. Simple
as they may seem, these statements are far from undisputed or self-­explanatory.
Controversy about the meaning and goal of antitrust law is as old as the law
itself – and even older, as it dates back to mid-­nineteenth-century debates over
the British common law restraints of trade.
One may legitimately ask what “competition,” “freedom to compete” and
“social welfare” exactly mean. Recognizing them as technical terms does not
help, because two technical and only partially overlapping jargons apply in the
field of antitrust: the language of law and the language of economics. The economic point of view has been on the rise during the last three decades of antitrust
law, but still the subject belongs to the legal realm. Antitrust enforcement is part
of the legal (and administrative) system; acquainted as they may be with economics, judges and agencies adjudicate cases following legal rules.
Even within the boundaries of economics, unsettled issues exist. For example,
economists have different ideas of what “competition” actually means. What is
competition? Two main characterizations prevail.1 In the first, competition is
viewed as a process, the product of the actions and reactions of sellers and
buyers bargaining in the marketplace. It is a force operating in the market that
does not coincide with any given market structure. Alternatively, competition
may be characterized as a state; that is, as a specific market structure, endowed
with certain desirable properties relating to equilibrium output and price. Historically speaking, the former view was typical of nineteenth-­century classical economists, the latter of twentieth-­century neoclassical ones. However, in the world
of antitrust both views have always co-­existed.
The same can be said of the notion of “freedom to compete.” When is competition free? Once again, two interpretations exist.2 According to the first, competition is free when market participants may exercise the utmost freedom of
contract – that is to say, when they have unlimited access to every possible
exchange opportunity and the full management of their property rights. In the
second characterization, free competition means freedom from market power, or
freedom to trade. Loosely speaking, market power may be defined as a market
participant’s capability of increasing her own surplus by constraining or coer­
cing other agents’ exchange opportunities or trade. In a freely competitive
market this power is kept at an insignificant level by the force of competition
itself; all agents are therefore on equal footing with respect to the possibility of
exploiting trade opportunities (though some agents may still have more opportunities than others).
The two interpretations are obviously related, but do not coincide. The key
difference resides in the dichotomy between market and non-­market coercion.
The government and the law are the main non-­market sources of constraints on
freedom of contract, in that they set boundaries to what an economic agent may
do with her own property rights. For example, the law may prohibit a merger –
that is, the free exchange of property – between two businesses. Hence, freedom
of contract may also be characterized as freedom from government or legal coercion. Together with the right to enjoy the fruits of one’s own work, this was the
basic kind of economic freedom for classical liberals at the time the first antitrust
statutes were enacted. Freedom to trade is on the contrary constrained first and
foremost by other agents’ market power. This may take the form of, say, supra-­
competitive prices, denial of access to essential inputs or territorial limitations.
Apart from the idealized situation of perfect competition, where no such power
exists by definition, what causes problems is not market power per se (as it may
be the legitimate fruit of superior talent and ability), but rather the way it is
employed to constrain or coerce other agents’ trade.
The ideal of freedom from market power is intimately related to neoclassical
economics and its idea of competition as a state. Market power itself is a technical notion that economists measure in terms of price/cost margins and market
shares. However, it also one that easily lends itself to a non-­analytical extension.
In the history of antitrust law, freedom from market power has often been interpreted as freedom from economic power. By the latter term is meant a kind of
power that trespasses upon the market and spreads its negative influence over the
whole society. A powerful business in this sense is one capable of affecting not
only a country’s economy, but also its politics and social life; a threat to democracy in its most basic nature of a system based on equal rights and duties. Antitrust law has a long tradition of looking suspiciously at large concentrations of
economic power, usually summarized in terms of sheer business size. Simplistic
as it may be, the idea that big is bad has been a driving force for much of the
subject’s history.
Economic power, as distinguished from market power, is also the reason why
even the notion of “social welfare” is problematic. Analytically speaking, the
notion may be interpreted in purely economic terms, such as allocative efficiency
or total surplus. Even broadening the analysis to encompass a dynamic setting so
as to accommodate the long-­run efficiencies generated by, say, product innovation leaves the basic theoretical framework unchanged. Setting social welfare as
the goal of antitrust law thus makes antitrust itself a branch of economic policy
that must be governed by economic analysis. All other concerns, such as
fairness, the plight of small businesses or, crucially, the socio-­political consequences of unbalanced economic power, become irrelevant. This is how
modern antitrust usually proceeds. However, when and if economic power is
viewed as the main foe, as it has often been throughout history, then the goal of
antitrust changes. It becomes, broadly speaking, the pursuit of marketplace egalitarianism, of a Jeffersonian ideal of an economy of “small dealers and worthy
men,”3 none of whom are capable of coercing anyone else and, therefore, of negatively affecting a country’s socio-­political life. Social welfare then takes a
broader, less rigorous meaning that transcends economics and even the law, in
that neither discipline may properly account for loose notions such as marketplace fairness or the protection of small businesses.
These considerations should suffice to reveal how difficult – and fascinating –
a topic the law and economics of antitrust may actually be. Even the simplest of
statements, such as “antitrust law is about competition” or “antitrust promotes
free competition,” conceal a universe of interpretive problems. The present book
is an effort to analyze the above-­mentioned dichotomic views of “competition,”
“freedom to compete” and “social welfare” from the vantage point of the history
of the economic analysis of antitrust. Three general results will emerge: first, that
these dichotomies have characterized the entire history of antitrust law; second,
that the courts’ evolving attitude towards them has largely determined the way
antitrust law has been enforced over the years; third, that the influence of theoretical economics upon this attitude has been anything but steady, as antitrust
courts have oscillated between a total neglect and a partial or full endorsement
of basic economic principles.
My analysis will focus on a single antitrust issue and a single country. I will
deal with the history of the law and economics of predatory pricing in American
antitrust. The geographical focus hardly requires explanation. In every respect,
the United States is the cradle of antitrust, the country where the discipline first
became a serious matter and where the relationship between the legal and the
economic sides of competition has been most intensively studied. But why predatory pricing? Why should the history of the law and economics of this specific
violation of antitrust statutes merit a book of its own? Is there anything special
about predatory behavior? And, in any case, why adopt a history of economic
thought viewpoint? Are there any lessons the historical method may teach
current antitrust enforcers? The remainder of the Introduction tries to answer
these legitimate questions.
2 The trickiest antitrust problem
Predatory pricing (PP hereafter) is an unlawful business behavior within the
broader category of unlawful exclusionary practices. A practice is exclusionary
reasonably capable of creating, enlarging, or prolonging monopoly power by
limiting the opportunities of rivals [and] either does not benefit consumers at
all, or is unnecessary for the particular consumer benefits produced, or produces harms seriously disproportionate to the resulting benefits.
(Hovenkamp 2005, 152)
A predatory price is then “a price that is profit-­maximizing only because of its
exclusionary or other anti-­competitive effects” (Bolton et al. 2000, 2242–3). In
other words, PP takes place when a firm sets such a low price that its only rationale is to damage competitors, current or potential. The predator’s eventual goal
is to increase its market power and charge a higher price in the future, after competition has been either disciplined or destroyed.
Historically speaking, PP surely ranks high in the catalogue of antitrust violations – at least as high as cartelization. And as with cartels, predatory behavior
has always symbolized what antitrust law is supposed to fight against. The iconic
picture of a big business preying upon its smaller rivals by setting the price so
low that none of them could survive is second to none in the history of antitrust
law, the only possible exception being the image of smoke-­filled backrooms in
which businessmen secretly agree to fix prices. Opposition to predatory behavior
was the primary motivating force of the American public opinion’s hostility
towards trusts and, therefore, one of the key impulses that led Congress to pass
the 1890 Sherman Act.
There is more to PP than mere history, though. The antitrust problem with
cartels is easy to apprehend. Cartels are clearly anti-­competitive – indeed, their
very goal is to avoid competition. While even joining a cartel may be seen as an
expression of a member’s own freedom of contract as much as the negation of
nonmembers’ freedom to trade, the fact remains that the harmful welfare effects
of cartelization are well established and largely undisputed. Nobody doubts that
fighting cartels means fostering competition. This is not so in the case of PP.
Predatory behavior is the paradigmatic example of using competition to destroy
competition – what several American economists at the turn of the twentieth
century called destructive competition. We know that defending the utmost
freedom to compete is supposed to be the core of antitrust. Mind-­boggling questions thus arise. Whose freedom to compete deserves antitrust protection – the
predator’s or the prey’s? Can a firm ever be condemned for competing too
much? Can a price ever be too low? In short, can competition really be destructive? Questions like these make anti-­PP enforcement one of the trickiest, if not
the trickiest part of antitrust law.
Enforcing law against PP means prohibiting competition to foster competition. The danger is clear. The law risks discouraging actual competition as
freedom of contract for the sake of protecting an abstract ideal of competition as
freedom from market power. The age-­old proscription of predatory behavior
indeed reflects a specific policy choice, namely, the idea that using the law to
curb a firm’s freedom to set its own price (i.e., to constrain that firm’s contractual freedom) may nonetheless foster freedom to trade, i.e., avoid undue concentrations of market or economic power. This policy choice is, however, far from
The trade-­off between the two freedoms, and between the conflicting views
of what free competition actually means, is therefore intrinsic to the law and economics of PP – and the chief reason why the subject deserves special scrutiny.
When still a Judge for the First Circuit, Justice Stephen Breyer once described
the trade-­off in the following terms:
A price cut that ends up with a price exceeding total cost – in all likelihood a
cut made by a firm with market power – is almost certainly moving price in
the “right” direction (towards the level that would be set in a competitive
marketplace). The antitrust laws very rarely reject such beneficial “birds in
hand” for the sake of more speculative (future low price) “birds in the bush.”4
The metaphor captures the power of PP to lay bare the most controversial features and deepest contradictions of antitrust law. “Using competition to destroy
competition” and “prohibiting competition to foster competition” are challenging statements that push to the extreme the antitrust project’s goal and method.
The law and economics of PP is the only framework where these statements
really make sense – and, therefore, also the best diagnostic tool for inquiry into
the very heart of antitrust.
3 Further reasons to love predation
That a low price may not necessarily be a good price is the chief reason for
taking PP law and economics as the most exciting vessel for sailing the turbulent
waters of antitrust law. It is not the only one, though. A few more are listed in
this section and the next.
3.1 The short-­run/long-­run tradeoff
Breyer’s “birds” highlight another crucial tradeoff. Every business practice has
short- and long-­run effects on social welfare.5 In most cases, economic theory
shows that these effects point in opposite directions. PP is exemplary in this
respect: consumers gain during predation, when prices are low, but suffer after
predation is over, when (and if ) the successful predator raises its price to a level
higher than before. Other instances of the tradeoff are patents, efficiency-­driven
mergers and essential facilities.
When an antitrust case involves a business practice characterized by the
short-­run/long-­run tradeoff, the court may reach a decision only by attributing
weights to the practice’s immediate and future welfare effects. The choice of
weights may seem theoretically driven, but it is not. Economics often fails to
provide objective grounds for the choice – by, say, proving that short-­run effects
always (or at least in this specific case) outweigh long-­run ones, or vice versa.
Assigning weights is frequently a normative operation even for the least
ideologically oriented court. It is a peculiar, one-­dimensional kind of normativeness, as it depends only on the court’s preference for short- over long-­run
consequences. Still a normative judgment it is, one that analytical arguments
cannot fully validate.
Not only is PP exemplary of the short-­run/long-­run tradeoff. The history of its
law and economics also highlights the inevitably normative nature of the courts’
choices in the face of that tradeoff. For a good part of the twentieth century
American courts emphasized predation’s negative long-­run effects over its positive short-­run ones. The consequence was a strict enforcement of the per se prohibition of predatory behavior. More recent PP case law has reversed this
attitude, with courts giving decisive weight to the short-­run gains guaranteed by
any price cut, regardless of its possible strategic motivation and negative long-­
run effects. The reversal mirrors the greater confidence of most contemporary
courts in the spontaneous ability of free markets to deliver their efficient outcomes in the long run, without any specific intervention by the law or the state.
Hence, it is believed that even successful predators will not enjoy their victory
long because new competition will surely, and quickly, erode any market power
they may have conquered.
This belief is clearly a normative judgment that finds no analytical justification in modern economics, exception being made for the most idealized version
of perfect competition. It is a judgment that is typical of many chapters of
current antitrust case law besides PP – but it is also one the true nature of which
only PP reveals with both clarity and immediacy.
3.2 The predatory paradigm for exclusionary acts
The previous definition of exclusionary acts is not the only one. Narrower definitions exist that characterize more specifically under what conditions a business
practice may be deemed exclusionary. Their goal is operational, as they tend to
be formulated in terms of a test that may help courts to identify violations of the
anti-­monopolization provision of antitrust law – that is, section 2 (§2) of the
According to Herbert Hovenkamp (2008, 114), the recent anti-­monopolization
literature “has been preoccupied to the point of obsession with the formulation
of a single test for exclusionary conduct.” In the so-­called sacrifice test, a firm’s
conduct violates §2 when it entails giving up some immediate profits as part of a
strategy whose profitability strictly depends on the exclusion of rivals. For
example, setting a low price today means sacrificing short-­run revenues in view
of the benefits that will accrue tomorrow thanks to the high price that follows the
creation of a monopoly or the strengthening of a dominant position. PP thus fully
partakes of the rationale for the sacrifice test, which aims at sanctioning genuinely competitive conduct, i.e., conduct that is profitable without regard to the
creation or preservation of monopoly. The sacrifice test is implicit in the way
contemporary antitrust courts handle PP cases.
A slightly different alternative is the “no economic sense” test, which condemns conduct that would be irrational (i.e., would make no economic sense)
except when used as a mechanism for excluding rivals and earning monopoly
profits. The test – which is also frequently used by modern courts – entails that
no single-­firm practice should be condemned per se, but only if its sole rational
explanation is that the firm used it to eliminate or lessen competition. Note that,
regardless of their weaknesses,6 both tests are highly operational. No calculation
of the given conduct’s net welfare effects is required because the mere existence
of a defendant’s gain that does not come from injuring competitors would suffice
to sanction that conduct.
Georgetown economist Steven Salop has classified popular tests like the sacrifice or the “no economic sense” under the banner of the predatory paradigm
for exclusionary acts.7 The paradigm is built on the idea that predatory behavior
epitomizes §2 violations. All kinds of exclusionary practices should be reduced
within the boundaries of PP, as they all partake of its key principle of suffering
losses now to earn more tomorrow. Given the current very lenient enforcement
of anti-­PP law, the paradigm’s implication is obvious. If all exclusionary practices are like PP, then it is very likely that, exactly like PP, they should cause
little, if any, antitrust concern.
The predatory paradigm thus explains why current §2 enforcement is based
upon highly permissive tests that would show violation in only a very few cases.
It is not just that the sacrifice or “no economic sense” tests are ill-­devised. The
real issue is that the trickiest of all antitrust violations, price predation, has been
taken as the foundation for all kinds of exclusionary behavior. Studying the law
and economics of PP may allow a better understanding of the paradigm’s limits
and help in the devising of more effective anti-­monopolization tests.
3.3 Big is bad
That big business is bad business is an idea that predates antitrust law and has
accompanied it throughout its existence. To quote from a famous case, the fear
that “the vast accumulation of wealth in the hands of corporations and individuals [. . .] and their power had been and would be exerted to oppress individuals
and injure the public generally”8 has been a major driver of antitrust legislation
It is not by chance that the previous passage came from Standard Oil. That
decision by the 1911 Supreme Court established the key precedent for more than
seven decades of anti-­PP case law. Rockefeller’s trust symbolized the “big is
bad” mantra in turn-­of-the-­century American culture, where the popular press
depicted Standard Oil as a giant octopus crushing smaller rivals to death.
The privileged way a trust could “oppress individuals and injure the
public generally” was, of course, by pricing at a predatory level, or by undertaking similar exclusionary acts. Hence, PP became the leading example of
everything that might be wrong with business size. The 1911 decision simply
The point is that American antitrust law did not condemn size per se – and
would never do so even in later decades. So-­called “no fault” structural remedies,
which called for the dissolution of giant corporations and trusts on account of
their mere size, never reached beyond the status of legislative proposals or academic debate. Moreover, despite decades of intense controversy, economic analysis has never offered a clear rationale for condemning size as such. Still, fear of
the negative consequences that “the vast accumulation of wealth” might cause the
economy and, therefore, also American society never disappeared from the antitrust landscape. How to reconcile the dread of economic power with the absence
of any legal or analytical justification for condemning business size per se?
Once again, PP came to the rescue. If predatory behavior symbolized the evil
of giant business, then what courts had to do was “just” search for evidence
about that very behavior. The idea was simply that if a business is big, it must
have preyed, or still be preying, upon its rivals. PP thus became a proxy – an
excuse, if you wish – to condemn size.9 This does not mean that Standard Oil or
other large businesses that, over the decades, have been found guilty of predatory behavior were actually innocent. Almost surely they were not. It is just to
recognize the role that PP has played in supporting the antitrust fight against economic, as distinct from merely market, power. As we said above, this was an
eminently socio-­political fight, aimed at preserving no less than American democracy, not just marketplace efficiency. The patterns of anti-­PP enforcement that
courts have applied over the years thus mirror the evolution of socio-­political
views about economic power at least as much as they track the progress of legal
and economic thinking about exclusionary behavior.
4 Lessons in persuasion
Reconstructing the history of PP law and economics may have another, broader
justification. Antitrust law in general, and anti-­PP law in particular, are ideal
fields to investigate the crucial theme of how economists persuade – that is, of
how, when and why theoretical economics may become a tool for concrete
policy- and law-­making. Under what conditions might economists be listened to
by policy- and law-­makers? Or, as I like to say, what kind of economic arguments have the highest chances of successfully migrating from classroom to
policy room or courtroom?
Focusing just on the legal realm, the answer hinges upon the different professional practices of economists and judges. Starting (at least) from World War II
(WWII), the former have striven for rigor and generality, accumulating new disciplinary knowledge in terms of mathematical models, that is, by way of idealized
representations of reality that by necessity abstract from seemingly irrelevant
details and specific circumstances. By contrast, judges’ interest and practice reside
in finding the most effective way to administer law in any given case, by taking
into account every single fact and detail of the trial record and in pursuit of whatever goal the law may have been assigned. It follows that, regardless of their
intrinsic theoretical or empirical validity, economists’ models have succeeded in
migrating from classrooms to courtrooms only when they enjoyed two properties:
that of being general enough not to depend upon idiosyncratic or heroic hypotheses, and that of being easily translatable into workable rules or principles.
The history of antitrust law offers several examples of that migratory pattern,
and even more so of cases where the migration failed – that is, where economists’ arguments were either totally neglected by judges and legislators or
endorsed on a purely ad hoc, inconsistent basis. So, for instance, it is well known
that American economists opposed in vain the enactment of the first antitrust
statute in 1890, severely criticized the Supreme Court’s rule of reason formulated in Standard Oil, and had a major direct influence in the passing of the 1914
Clayton Act. The ebbs and flows of economists’ efforts to persuade antitrust
judges and legislators continued over the following decades.10 Antitrust is therefore an invaluable source of teachings for grasping the power of economics to
The law and economics of PP is especially rich in this respect. As the following chapters show, the evolution of theoretical reflections about predatory behavior offers a whole array of different styles of economic reasoning: from basic
price-­theoretic models to semi-­automatic rules, from vague “economic-­flavored”
arguments to rigorous game-­theoretic analysis. Understanding how, when and
why these different approaches managed to persuade courts – or failed to – may
thus provide a useful case study. In particular, the erratic fortune of PP models in
courtrooms seems to validate the previous claim that economists’ practices can
be compatible with those of judges only in those special cases where the product
of the former’s theorizing is at the same time general enough and sufficiently
5 Treasures in the attic
Common law systems naturally lend themselves to an appreciation of the historical evolution of legal doctrines and enforcement practices. Due to the rule of
precedent, entire areas of the law may be presided over by age-­old principles. A
few of these principles may sometimes have been inspired, either directly or
indirectly, by economic reasoning. As a consequence, traces of old economic
ideas may still survive in common law. This is clearly a boon for historians of
economic thought. The law is one of those rare fields where historians have an
edge with respect to theoretical or applied economists.
Antitrust law is the best example. Its statutes have gone almost unchanged for
a century or more. Key case law doctrines have provided the ruling precedents
for many decades. Old ideas, sometimes dating back to the late nineteenth and
early twentieth century, still hold sway in various chapters of antitrust law. Save
for a few later amendments introduced by Congress, changes in enforcement
have always been due to changing interpretations of the same norms. Hence, one
may understand current enforcement patterns by tracing back what particular
interpretation of the law underlay a given doctrine at the time it was formulated.
Saying that history is essential for understanding antitrust law is hardly a
novelty. Since 1890 antitrust scholars, judges and practitioners have continually
turned to history as a fundamental source of guidance, insight and justification.
Historical research has helped illuminate both the original legislative intent and
the meaning of earlier case law. Courts at all levels have always based their antitrust opinions on historical evidence and interpretation – and they still do.11
However, the term “history” in antitrust has always meant legal history, as
written by lawyers themselves for their own direct use or, more recently, by professionally trained legal historians.12 While the latter have questioned the naïve
view that “the legal past speaks authoritatively to the legal present” (Ernst 1990,
879), thereby paving the way to a more mature understanding of the inevitable
historical contingency of the legal system, it remains true that the history of antitrust has so far been entirely reconstructed using the language and methods of
legal history.13
This is somehow unfortunate because antitrust law has always been related
to, when not directly affected by, the economic analysis of firms, markets and
competition. But economic theory has never been a datum. Just think of the
evolving meaning, since 1890, of key concepts such as market, technology,
welfare, efficiency and, of course, competition. Economists over the years have
shaped, dissected and rebuilt each of these concepts. Through a multiplicity of
avenues the fruit of these economists’ efforts has eventually reached antitrust
enforcers, or legislators, influencing their own work. “Because the [Sherman
Act’s] vital terms directly implicated economic concepts, their interpretation
inevitably would invite contributions from economists,” wrote Bill Kovacic and
Carl Shapiro. “As economic learning changed, the contours of antitrust doctrine
and enforcement eventually would shift, as well” (Kovacic and Shapiro 2000,
43). If we accept that changing economic ideas have played an important role in
shaping antitrust statutes and case law, then it is only natural to turn to the discipline the professional goal of which is precisely to investigate the historical
evolution of those very ideas, namely, the history of economic thought (HET).
Think of a basic question one may legitimately raise in the face of every antitrust decision: what kind of economic “theory” (in the broadest sense of the
word) did the court have in mind when making that decision? I claim this is a
question that only HET may properly answer; and, equally importantly, one that
contemporary economists cannot answer. Acknowledging what today’s antitrust
economics says about a certain business practice that the given decision condemned falls short of explaining why that practice was prohibited in the past,
why that prohibition held for a long time, and why it still does. Only historians
are equipped to asses what the “contextual” (read: theoretical, political, social,
legal, etc.) conditions and goals were that led an old court to first prohibit that
practice, and that justified maintaining the prohibition every time the same practice was challenged in later cases. And only historians of economic thought may
fully appreciate a circumstance that contemporary economists often forget,
namely, that economic theories are never developed in a vacuum, that we may
never take the universal value of economic principles for granted, that some
economic arguments are compatible only with some contextual conditions and
goals while others are not. What economic ideas were compatible with, say, the
socio-­politico-legal context of 1911 America, when Standard Oil was decided
and PP prohibited – a prohibition that lasted for the next seven decades? What
about those economic ideas that were not compatible, and thus were dismissed
by antitrust courts regardless of their theoretical “correctness” in terms of
today’s economics?
Applying the HET viewpoint allows the answering of questions like these,
and even more. As the following chapters show, the history of the law and economics of PP also helps us to understand that economic ideas may and, on occasion, do resurrect, and thus that economics does not proceed linearly, as Whig
historians would claim.14 Progress in economics, especially in applied fields like
antitrust, may come from unexpected quarters, including some seemingly dead-­
and-buried ones. For their part, contemporary economists should therefore reject
theoretical foreclosures and remain open to the possibility of surprising returns.
Indeed, it would be only rational for them to do so. Records show that the
true test of economic ideas in antitrust law has never been their conformity to the
most up-­to-date analytical frontier, but rather their concrete applicability to real
world cases. Big money usually awaits those economists who, working as expert
counsel in antitrust litigations, are able to select the right theory for the right
case. HET is there to remind them never to forget the old treasure trove of ideas
their forefathers left in the attic.
6 Plan of the book
The remainder of this book is organized into eight chapters and a conclusion.
In the first chapter I offer a brief survey of the economic models of PP, from
the so-­called basic story to more sophisticated Bayesian game theory. The
exposition is deliberately non-­analytical, to help readers devoid of advanced
mathematical skills (a knowledge of basic microeconomic principles is the only
Chapter 2 deals with the late nineteenth-­century British common law of
restraints of trade, the area of the law in which PP cases, like the early 1890s
Mogul Steamship, were first litigated. British law fostered the utmost freedom of
contract and was the benchmark for American courts when Congress enacted the
first antitrust statute.
The American economists’ heterogeneous views at the turn of the twentieth
century about antitrust in general, and so-­called destructive competition (of
which PP was the main example) in particular, are the theme of Chapter 3.
The fourth chapter covers the formative era of American antitrust, starting
with Congressional debates about the Sherman Act (1890) and ending with the
approval of the Clayton and FTC Acts (1914). In between came the first two
decades of antitrust enforcement, an extraordinary period when landmark cases
were decided, including the 1911 Standard Oil.
The focus of Chapter 5 is on so-­called structuralist antitrust, the period of
most active enforcement between WWII and the late 1960s. These years are
characterized by the structure-­conduct-performance approach on the theoretical
side and the Warren Court’s antitrust doctrines on the jurisprudential side.
The period ended with a serious crisis of antitrust, of which the Court’s anti-­PP
doctrine (as in the 1967 Utah Pie case) was among the clearest examples.
In Chapter 6 I present the reaction to this crisis by the Chicago School. Not
surprisingly, the reaction started from criticism of PP case law. Launched by
John McGee in 1958, the attack culminated with the declaration that PP was de
facto impossible as a business strategy and should therefore be ignored as an
Simultaneously, two Harvard law scholars, Phillip Areeda and Donald Turner,
proposed in 1975 a different way out from the crisis of anti-­PP enforcement in
terms of a straightforward price/cost rule that courts could easily apply. Chapter
7 deals with the development of that rule, how courts swiftly adopted it, and the
big debate it raised in antitrust law and economics.
The eighth chapter covers both the triumph of the Chicago interpretation of
PP, symbolized by the Supreme Court’s decisions openly endorsing it, and the
failure to date of the so-­called Post-­Chicago approach to win the courts’ attention despite the recognized superiority of its game-­theoretic analysis.
A short conclusion offers some final thoughts on what the Post-­Chicago
fiasco may teach about the possibility of sophisticated economic arguments successfully migrating from classroom to courtroom.
1 See, for example, McNulty (1968); Blaug (1997); Salvadori and Signorino
2 See Peritz (1996); Steiner (2007); Page (2008).
3 To borrow Justice Peckham’s formula in United States v. Trans-­Missouri Freight
Association, 166 U.S. 290 (1897), at 323.
4 Barry Wright v. ITT Grinnell Corp., 724 F.2d 227 (1st Cir., 1983), at 234.
5 See Devlin and Jacobs (2010).
6 On which see Hovenkamp (2008, 114–16).
7 Salop (2008, 142–4). As an alternative, Salop proposes his own raising rivals’ costs
8 Standard Oil Co. v. United States, 221 U.S. 1 (1911), at 50.
9 This especially until 1950, when Congress eventually amended antitrust law to allow
a more effective anti-­merger policy. Challenging mergers that would result in a large
concentration of power then became an alternative method of fighting size than pursuing predation.
10 Once again then-­Judge Breyer nicely summarized the issue: “While technical economic discussion helps to inform the antitrust laws, those laws cannot precisely replicate the economists’ (sometimes conflicting) views. For, unlike economics, law is an
administrative system” (Barry Wright, at 234).
11 See May (1990, 857).
12 For the evolution of the legal history of antitrust, see Ernst (1990); May (1990).
13 No intention to downplay that literature, though. Legal history of antitrust includes
gems like Hovenkamp (1991), Freyer (1992) and Peritz (1996) that will be our
guiding lights in the following chapters.
14 According to the so-­called Whig, or incrementalist approach to the history of economics (Samuelson 1987), present economic theory is the outcome of the accumulation of “correct” ideas, while all other, forgotten ideas have been rightly abandoned as
The economics of predatory
1 Classic and modern definitions of predatory pricing
The second section of the Sherman Act reads:
Every person who shall monopolize, or attempt to monopolize, or combine
or conspire with any other person or persons, to monopolize any part of the
trade or commerce among the several States, or with foreign nations, shall
be deemed guilty of a felony, and, on conviction thereof, shall be punished.
Legally speaking, the offense of monopolization – or §2 offense, as it is often
called – requires proof of a dominant firm with substantial market power and at
least one qualifying exclusionary practice. The latter may be defined as an act
1. is reasonably capable of creating, enlarging, or prolonging monopoly
power by limiting the opportunities of rivals; and 2. either does not benefit
consumers at all, or is unnecessary for the particular consumer benefits produced, or produces harms seriously disproportionate to the resulting
Predatory behavior is one such practice. It is therefore a §2 offense, explicitly
forbidden by antitrust law. While the legitimate aim of any competitive act is to
increase one’s own profit and while this may often legitimately happen only at
the expense of one’s own competitors, what characterizes predation as an unlawful exclusionary practice is the circumstance that the predatory act would not be
profitable absent its exclusionary effect. This feature is emphasized in the following classic definitions:
Predation may be defined, provisionally, as a firm’s deliberate aggression
against one or more rivals through the employment of business practices
that would not be considered profit maximizing except for the expectation
either that (1) rivals will be driven from the market, leaving the predator
with a market share sufficient to command monopoly profits, or (2) rivals
14   The economics of predatory pricing
will be chastened sufficiently to abandon competitive behavior the predator
finds inconvenient or threatening.
(Bork 1978, 144)
Predatory behavior is a response to a rival that sacrifices part of the profit
that could be earned under competitive circumstances, were the rival to
remain viable, in order to induce exit and gain consequent additional monopoly profit.
(Ordover and Willig 1981, 9–10)
Several business practices may fall within such broad definitions. This book
will focus on the most frequent, and famous, of them, predatory pricing (PP
hereafter). The practice is defined in the Oxford English Dictionary as “the
setting of uneconomically low prices in order to damage one’s competitors or
put smaller rival companies out of business.” US law gives a similar definition.
In Title 15, Ch. 1, §13.a of the so-­called US Code we read: “It shall be unlawful
for any person engaged in commerce, in the course of such commerce [. . .] to
sell, or contract to sell, goods at unreasonably low prices for the purpose of
destroying competition or eliminating a competitor.”1
This prohibition did not feature in the Sherman Act, nor in the original formulation of the Clayton Act, to which it has been added only in 1936, as §3 of the
Robinson–Patman Act. PP may therefore violate two different laws: the Clayton
Act, as amended by the Robinson–Patman Act, and, as an instance of exclusionary practices, §2 of the Sherman Act. The two violations are treated in the same
way in modern case law. As the US Supreme Court clarified in a landmark
Competitive injury under the Robinson–Patman Act is of the same general
character as the injury inflicted by predatory pricing schemes actionable
under §2 of the Sherman Act. [. . .] The essence of the claim under either
statute is the same: A business rival has priced its products in an unfair
manner with an object to eliminate or retard competition and thereby gain
and exercise control over prices in the relevant market.
(Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209
[1993], at 221–2)
The notion of “unreasonably low price,” mentioned by US law, or that of “unfair
pricing,” used by the Supreme Court, are given concrete meaning by comparing
price to production costs. For example, in the OECD glossary of industrial economics we read that PP is:
A deliberate strategy, usually by a dominant firm, of driving competitors out
of the market by setting very low prices or selling below the firm’s incremental costs of producing the output (often equated for practical purposes
with average variable costs). Once the predator has successfully driven out
The economics of predatory pricing   15
existing competitors and deterred entry of new firms, it can raise prices and
(OECD 1993, 67)
This definition calls into play a list of elements – a dominant firm, a price below
the rival’s costs, two phases, two possible goals (forcing exit or deterring entry)
– which feature in all PP definitions given by modern industrial economists. A
One of the most popular Industrial Organization (IO hereafter) handbooks
defines PP as:
a strategy in which a dominant firm cuts price below rivals’ average cost,
even if this means accepting short-­run losses, to drive rivals from the
market. Once rivals leave the market, the incumbent raises price and collects sufficient economic profit to make the present-­discounted return from
predatory pricing positive. A variation is that a dominant firm cuts price as a
way of encouraging rivals to compete less vigorously, without necessarily
driving them from the market.
(Martin 2002, 246)
Another recent textbook on competition policy explains that predatory pricing
occurs when a firm sets prices at a level that implies the sacrifice of profits
in the short-­run in order to eliminate competition and get higher profits in
the long-­run. This definition [. . .] contains the two main elements for the
identification of predatory behaviour in practice: first, the existence of a
short-­term loss; second, the existence of enough market power by the predator so that it can reasonably expect to be able to raise prices so as to
increase profits in the long-­run once a rival (or more rivals) has been driven
(Motta 2004, 412)
The conditions making PP profitable are stated in another popular volume: when
incumbents lower their prices,
this is defined to be predatory pricing only when the intent is exclusionary;
that is, profitable only because it will result in a higher future price in this or
some other markets by virtue of inducing exit or deterring entry in those
(Viscusi et al. 2005, 307–8, original emphasis)
In light of the aim of the present book, two further definitions may help. What
makes these additional definitions especially attractive is that they present the
alternative views of PP – the classic and the game-­theoretic one – which, as the
next sections show, have animated the debate about the economics of predatory
16   The economics of predatory pricing
behavior. In his influential 1970 exposition of IO, Mike Scherer gave a lengthy
explanation of PP in the following terms:
One of the purported traits of large, financially powerful conglomerate firms
is their greater ability and willingness to engage in sustained price-­cutting
with the intent of disciplining smaller competitors or even driving them out
of the market. [. . .] The most extreme form of predatory pricing takes place
when a seller holds price below the level of its rivals’ costs (and perhaps
also its own) for protracted periods, until the rivals either close down operation altogether or sell out on favorable terms. The predator’s motivation is
to secure a monopoly position once rivals have been driven from the arena,
enjoying long-­run profits higher than they would be if the rivals were permitted to survive. Even if it must itself sustain losses during the price war,
the predator can afford to do so because it can draw upon profits earned
selling the same product in other geographic territories, or from selling different products. In other words, it subsidizes its predatory operations with
profits from other markets until the predation creates conditions which will
repay the original subsidy.
(Scherer 1970, 273)
It is convenient to juxtapose this long passage with the definition provided by
Patrick Bolton, Joseph Brodley and Michael Riordan (BBR) in their oft-quoted
paper sponsoring the adoption by US courts of the game-­theoretic approach:
Predatory pricing is defined in economic terms as a price reduction that is
profitable only because of the added market power the predator gains from
eliminating, disciplining, or otherwise inhibiting the competitive conduct of
a rival or potential rival. Stated more precisely, a predatory price is a price
that is profit-­maximizing only because of its exclusionary or other anticompetitive effects. The anticompetitive effects of predatory pricing are higher
prices and reduced output – including reduced innovation – achieved
through the exclusion of a rival or potential rival.
(Bolton et al. 2000, 2242–3)
These two long quotes have several common elements, but also exhibit significant differences. Both definitions consider market power as a precondition for
PP, view the increase in such power as the source of the extra profits repaying
the losses of predation, and extend the goal of predation from the sheer elimination of rivals to the disciplining of their competitive behavior. In short, both definitions characterize PP as “an investment in the creation of market power.” Like
any other investment, a predatory strategy partakes of the “suffer a cost now to
get a bigger gain tomorrow” nature – i.e., it is an inherently intertemporal
However, the differences between the two definitions are even more significant than their commonalities. First of all, Scherer’s definition only applies to a
The economics of predatory pricing   17
big firm trying to achieve monopoly starting from an already dominant position.
Bigness is deemed necessary for sustaining the predatory investment, because
size (to be understood as “presence in other markets”) warrants the availability
of the financial resources enabling the predator to survive the losses. As industrial economist Corwin Edwards reportedly said: “The large company is in a
position to hurt without being hurt” (quoted by Scherer 1970, 273). Thus, a precondition of PP is that the predator be endowed with economic – as distinguished
from mere market – power. While market power is a strictly theoretical notion –
to be measured via analytical tools, such as market shares or the Amoroso-­
Lerner index – economic power is a broader, non-­measurable notion, which
encompasses all the powers – financial, political, social – bestowed upon a firm
by its sheer size and the assessment of which goes beyond the limits of economic analysis.2 Second, Scherer identifies PP as selling below cost – by which
he surely means below rivals’ costs, and possibly also below one’s own. Third,
his definition explicitly mentions the requirement of intent: the big firm’s price
cut must be deliberately aimed at harming its competitors. Finally, Scherer’s definition views PP as a strategy only directed against existing rivals.
The alternative definition by BBR is more general under all these respects.
First, their definition only requires that the predator be endowed with some
market power, to which the predatory strategy is said to add. Nowhere, not even
implicitly, is the predator required to be either a big or a dominant firm, nor to be
active in multiple markets, nor to aim at full monopoly. Economic power falls
outside of their discourse, which remains entirely within the boundaries of economic analysis. Second, there is no necessary relation between price and costs:
all that is required is that the price charged by the predator be a seemingly irrational one, were it not for its power-­augmenting effect. Even the notion of the
predator’s losses is generalized from actual losses (negative profits) to the
broader idea of foregone profits. Third, this definition intentionally eschews any
reference to the predator’s intent, let alone some specific intent to monopolize.
As the next chapters show, the intent requirement has always caused trouble to
the enforcement of PP legislation. It is not surprising that a modern definition
eschews it. Finally, BBR explicitly refer to the possibility that PP may be directed at curbing potential competition by deterring entry. This is consistent with
the notion of anticompetitive effects (in terms of higher prices and reduced
output) which features as another key novelty of their definition. While Scherer’s
definition may also encompass a characterization of antitrust law as directed at
protecting a big firm’s competitors, especially small ones, BBR unambiguously
depict the law’s goal as the protection of competition, rather than competitors, to
be achieved by preventing the competitive harm caused by PP.
Historically speaking, Scherer’s narrower version corresponds to what we
may call the classic definition of PP, while that of BBR is the modern one. The
word “classic” here denotes that this has been the definition which, more or less
explicitly and more or less exactly, several generations of industrial economists
have made their own, commencing in the last two decades of the nineteenth
century, proceeding with full force after WWII and ending only with the rise of
18   The economics of predatory pricing
the game-­theoretic approach to IO in the early 1980s. The latter approach would
provide a broader characterization of PP, properly represented by BBR’s
“modern” definition.
However, even the classic definition of PP never fully overlapped with the
narrative that US courts had in mind when asked to apply antitrust law to allegedly predatory episodes. In what we may dub the classic legal standard of PP,
the specific theoretical elements of Scherer’s definition – market dominance,
monopoly position, below-­cost pricing, loss subsidizing, etc. – were dissolved
into a vague narrative that emphasized its non-­analytical components, like the
“unfair use” of pricing policy against smaller rivals or the multi-­faceted risks
(economic, political, social) implicit in any concentrated market structure. In that
story, PP just meant that a big firm had unfairly exploited its power to undercut
its smaller rivals, with the intention of further increasing that power by causing
them to exit the market. For more than 60 years, from 1911 to 1975, US courts
have been enforcing the anti-­PP prohibition guided by a legal standard that
hinged on that story, rather than on economic analysis. Accordingly, the goals to
be pursued were the protection of small firms from unfair price cuts made by
bigger rivals and the preservation of a competitive market structure, understood
as absence of excessive agglomerations of economic power. In short, protecting
competitors and diffusing economic power were the real drivers of anti-­PP
enforcement. Economic efficiency was never specifically articulated as a distinct
Following the classic legal standard, courts looked for the two essential elements of its underlying narrative: a considerable economic power and the intention to prey upon smaller rivals, i.e., to unfairly exploit that power. Power and
intent thus constituted the two necessary ingredients of any accusation of predatory behavior. Curiously, both the standard and the underlying story were closer
under a crucial respect to BBR’s definition of PP than to Scherer’s: US courts
could apply the standard without, strictly speaking, any comparison between the
predator’s price and its or its rival’s costs. Though in practice such a comparison
did represent the core issue of most PP cases, it was possible for a big firm to be
found guilty of predatory behavior despite pricing above cost. What really mattered was, first, that it was a big firm, and, second, that the court was convinced
that it had unlawfully intended to prey upon its smaller rivals.
This approach brought troubles to PP case law. Too many decisions by courts
guided by the classic legal standard showed a weak economic rationale – if any
at all. The situation became explosive with the post-­WWII intensification of antitrust activity, and all the more so in the 1960s, when sheer business size became
the declared target of antitrust enforcement. Things changed only in the mid-­
1970s, when courts replaced the classic legal standard with a new approach,
founded upon mainstream price theory and, above all, upon a clear-­cut rule,
rather than a vague story. Yet, by the time the change took place, the economic
analysis of PP was on the verge of another quantum leap, away from Scherer’s
classic definition and towards BBR’s strategic one.
The economics of predatory pricing   19
2 The basic story
The distance separating the vague narrative underlying the classic legal standard
from the more specific story supporting the economists’ classic definition of PP
becomes clearer when the latter is more closely analyzed. Notwithstanding its
shortcomings, that story provides a good benchmark for comparing the way anti­PP law has been enforced by US courts for many decades and how it should
have been, if only judges and juries had paid more attention to what industrial
economists were telling them. This section and the next aim at reconstructing the
economists’ classic narrative of PP – what we may call the basic PP story – and
the critiques raised against it from the late 1950s onwards.
Any PP story founded upon economic analysis must answer two fundamental
questions. What market structure is necessary for price predation to be a
profitable strategy? What market structure is necessary for price predation to be
actually undertaken by a rational firm? The first question aims at determining
under what conditions PP is a strategy with a positive net present value (NPV),
i.e., is profitable in an absolute sense. The second question, which only
makes sense in case of a positive first answer, looks at whether predation is more
profitable than any other alternative strategy, i.e., it deals with PP’s relative
The basic PP story is a stylized narrative of the events and conditions
required for an affirmative answer to the first question. The story runs as
A market leader exists who has market power in two or more markets,
separ­ated by either geography or product categories. In short, the leader is a
multi-­market firm earning supra-­competitive profits in all its markets.
In one (or more) of these markets the leader has one or more competitors,
selling the same product. The rivals are active only in that market, i.e., are
single-­market firms. Hence, the leader is not a monopolist in these markets.
[As a variant of the first two points, the leader may also be a single-­market
firm that used to be a monopolist in that market, but now faces the entry of a
rival and thus has to give up its monopoly.]
To further increase its profits, the leader may behave as predator in the
market where it faces competition. [In the variant, the goal is to preserve the
monopoly position.] To do so, it sets a price lower than its own marginal (or
average variable) cost. This is the predatory phase. On the assumption that
the rival has the same cost structure (or worse) than the leader’s, both the
leader and the rival suffer losses from such a low price.
The leader may bear those losses for a significant amount of time, due to the
supra-­competitive profits earned in his other markets – in PP jargon, due to
its deep pocket or long purse. This is not so for the single-­market rival,
which has no deep pocket and is thus forced to exit the market, or go bust.
(In the variant, the leader survives the losses thanks to the reserves accumulated when it was a monopolist.) Note that it is not required that the leader
20   The economics of predatory pricing
raises its price in any of its other markets to survive the predatory phase (the
assumption being that in those markets it is already pricing at the profit-­
maximizing level).
As soon as the rival leaves the market, the leader may raise the price to the
monopoly level, earning higher profits than before. (In the variant, the leader
regains its initial monopoly.) These extra profits allow it to more than
recover the losses suffered during the predatory phase. This is the recoupment phase, which ends the strategy.
Simplistic as it may be, this basic story has driven the economics of PP for more
than half a century, from the late nineteenth century to, at least, 1958, when it
was first seriously questioned. Despite the subsequent critiques, the story
remained the benchmark in IO textbooks well into the 1980s, when it was eventually supplanted by more sophisticated game-­theoretic narratives. Its key
element, namely, that predation means pricing below cost, has constituted the
theoretical pillar for the score of price/cost rules that economists and law scholars have developed since 1975 to help courts enforce the anti-­PP prohibition.4
Even the ruling doctrine in US case law, formulated by the Supreme Court in a
1993 case, is founded upon the basic PP story – if only to express the Court’s
skepticism about its real-­world significance.
Three remarks on the basic story are in order. First, the story highlights the
intertemporal dimension of PP. The strategy may be profitable only as long as
the leader earns extra profits in the recoupment phase that are big enough to
more than compensate the losses suffered during the predatory phase. Predation
thus partakes of the investment logic, i.e., bearing costs “today” in order to earn
more “tomorrow.” PP is an investment in the creation of market power (or, in
the variant, in its preservation). The second remark has to do with the leader’s
cost and production structure. An implicit assumption is that the leader may
satisfy the additional demand which follows the price cut by boosting its supply
at non-­increasing average cost. This is to exclude the possibility that the leader’s
strategy be defeated by its own rising costs depleting even a very deep pocket.
Finally, from the consumers’ viewpoint, the basic story entails a short-­run
increase in consumer welfare, lasting as long as the predation phase, followed by
a long-­run (possibly permanent) welfare loss when the leader becomes (or, in the
variant, returns to being) a monopolist.
Returning to the two above-­mentioned questions, we may note that the basic
story deals only with the first. Depending on the length of the two phases, and on
the amounts of the gains and losses attached to them, the story identifies the conditions warranting the strategy’s positive NPV, i.e., that PP be profitable in an
absolute sense. However, the story is silent about any alternative strategy that
the leader may find more profitable than price predation, i.e., we do not know
whether PP is the most profitable strategy.
The determinants of PP’s absolute profitability may be easily stated. The
strategy’s NPV depends, in the basic story, on three elements: the amount of the
losses during the predatory phase, the amount of the extra profits during the
The economics of predatory pricing   21
recoupment phase, the discount factor. The latter element is the easiest to handle.
Any investment’s NPV diminishes ceteris paribus with the increase in the discount factor, that is, with the preference for a dollar today over a dollar tomorrow. It follows that a myopic leader, which discounts future gains a lot, would
be less likely to undertake a predatory strategy, while a far-­sighted leader would
be more willing to implement it.
The other two elements are trickier. The losses suffered by the leader depend
on two key factors: the size of the price cut and the length of the predatory
phase. There is a clear tradeoff between the two: the lower the price, the heavier
the losses on each unit sold for both the leader and the rival, the shorter the latter’s resistance and thus the shorter the predatory phase itself. The leader must
therefore set the price to optimally handle the tradeoff between its own losses
and the time required to force the rival’s exit. The length of the predatory phase
also depends on the structure of the rival’s costs, in particular on the relative
amount of its sunk costs, i.e., costs which cannot be recovered if the firm quits
production. If much of its costs are sunk, the rival will be harder to “kill”
because it will try to resist as much as possible in order to avoid turning its un-­
retrievable costs into pure losses.
Sunk costs also provide a first counter-­argument to the basic story. At least
part of the rival’s sunk costs are usually embodied by some physical assets – say,
its plant – which could be purchased by another firm at a low, but positive, price.
The new firm would be lured into the market by the supra-­competitive profits
warranted by its structure – say, a leader/follower duopoly – as well as by the
possibility of avoiding any entry or other sunk cost, because they have already
been paid by the original rival. As long as the rival’s assets are “out there” – and
if they are sunk, it is going to be a long time – this entry possibility always
exists. The entry of a new competitor purchasing the original one’s assets would
doom the PP strategy, by recreating competition and indefinitely postponing the
recoupment phase.5
The gains to be earned during the recoupment phase depend on the price the
leader-­turned-monopolist can charge and the duration of its newly acquired
monopoly position. The existence of entry barriers protecting the leader from
new competitors plays a key role here. Yet the basic story does not even mention
these barriers. A second critique of that story is therefore that the absolute profitability of PP crucially depends on a neglected feature. Ignoring entry barriers is
perhaps the worst drawback of the basic story. In the limiting case of a perfectly
contestable market, where no such barriers exist,6 PP would never be profitable
because new rivals would always enter as soon as the leader raises its price following the original rival’s exit. Only the existence of absolute barriers, protecting it from new entry regardless of price, would guarantee the leader the
possibility to price at the monopoly level. In the intermediate, and most common,
case of non-­negligible barriers, a new trade-­off ensues between the price set by
the leader in the recoupment phase and the length of the phase itself: the higher
the price, the larger the revenues, but also the easier the entry of new rivals interrupting recoupment. The same sunk costs that make it harder to “kill” the rival
22   The economics of predatory pricing
during the predatory phase may, after the rival’s “death” with no surviving asset,
provide a considerable barrier protecting the leader’s recoupment.
3 The Chicago critique of the basic story
Following John McGee’s opening salvo in 1958,7 the Chicago School of antitrust has raised several objections against the basic story. A first collection of
critiques aims at demonstrating that PP can never be a profitable strategy and
therefore will be never undertaken by a rational firm. A second group of objections attack the basic story for neglecting alternative strategies that are always
more profitable than PP. Both sets of critiques conclude that rational firms would
never implement a predatory strategy. But if this is so, antitrust law should not
pursue a non-­existent behavior. If a low price can never be a predatory price,
then any price cut is always a sign of genuine competition – a kind of behavior
that antitrust law should encourage, rather than punish. In short, according to the
Chicago School a proper account of the basic story and its limits shows that antitrust law should stop worrying about PP.
As we know from the previous section, the first group of critiques concern the
missing elements in the basic story’s description of the two phases, predation
and recoupment. For instance, a classic Chicago argument is that the predation
phase will never end because the rival will never “die.” Despite undercutting by
the leader, the rival will resist indefinitely thanks to the support received by
either its customers or the financial market. Help from financial markets is justified, according to Chicago scholars, by the extra profits the firm will necessarily
earn if it survives predation. The existence of these extra profits we may take as
certain, first because the market is, by assumption, less than perfectly competitive and, second, because only the expectation of earning such profits would
justify the firm’s costly efforts to resist predation in the first place. Financial
markets should always be willing to finance the firm’s resistance, in the reasonable expectation of recovering their credit once the predation phase is over and
the price returns to the initial, supra-­competitive level. This financial help makes
up for the firm’s lack of a deep pocket by exploiting its future earnings.
As for the firm’s customers, the Chicago claim is that they should continue
purchasing from it at a price higher than that of the leader. Rational customers
should understand that the short-­run gain of buying from the leader at a below-­
cost price would be more than compensated by the future monopoly price, to be
paid as soon as the rival is “dead” and the leader has become a monopolist. Provided they do not discount the future too much, customers would prefer to bear
today the cost of “keeping competition alive” in view of the welfare gains such
competition would grant them tomorrow. Assuming its customers’ rationality
and far-­sightedness, the rival could avoid following the leader in the price cut
and charge its usual price, thus defeating predation.
Both objections to the basic story are themselves open to criticism. Consider
the supposed aid of financial markets. Asymmetric information and other market
imperfections may hinder such help. Potential lenders may be unable to foresee
The economics of predatory pricing   23
the rival’s future profitability. Or they may doubt the rival’s possibility of surviving predation and repaying its loans. Financial help may therefore be unavailable. Though Chicago economists have countered these objections by requiring
that critics specify the alleged imperfections in the capital market,8 it is undeniable that a (usually) small firm subjected to a predatory attack by a (supposedly)
big market leader is not exactly the kind of business real-­world lenders would
rush to finance.
Even more compelling is the objection against customers’ help. The Chicago
argument neglects the free riding opportunity every rational customer could
exploit, buying at a low price from the leader in the expectation that other customers will ensure the rival’s survival by purchasing from it at a higher price.
Preserving competition in the market is a kind of public good which every customer would be happy to “consume,” but which none is willing to pay for. As
with every other public good, it is up to the policy-­maker to guarantee the “production” of competition in the marketplace. The Chicago counter-­argument here
is that a firm under predatory attack may circumvent free riding by offering its
customers a more complex contract. For example, it could enter into a long-­run
commitment to always sell the good at a price lower than the monopoly level
(i.e., the price a successful predator would charge), provided the customer buys
from it in the short run. Such a contract should entice rational (and not too
myopic) customers to overcome free riding temptations and support the firm’s
resistance to predation. Leaving aside the complexity and cost of those long-­term
contracts, the implicit Chicago assumption is that customers entering into them
must possess, like lenders in financial markets, a considerable degree of rationality and forecasting capability. Moreover, they must trust the firm’s ability to
survive predation and be still around to honor its long-­run commitment. Such
customers forfeit an immediate bargain (buying at low price from the predator)
in the hope of a future gain, which might never materialize.
Finally, Chicago scholars claim that, even accepting that PP may sometimes
be a profitable strategy, it will never be undertaken by a rational firm because at
least one other strategy exists that is always more profitable: the takeover
strategy, i.e., the direct and immediate purchase of the competitor. The predator
may offer to acquire its rival’s business at a price between the value of the rival’s
future discounted profits, at the minimum, and the value of the leader’s post-­
takeover future discounted profits, at the maximum. The takeover is surely more
profitable for the leader than predation; at the same time, a rational rival will
always accept the leader’s offer rather than risk predation. The rival is being
offered for the takeover a sum that is, at the minimum, equal to the value of its
future profits.9 Any predatory episode, regardless of its length and eventual
outcome, would surely diminish this value, so every firm fearing predation
would willingly pocket it for certain, accepting the leader’s proposal. As to the
leader itself, takeover is always more profitable than predation because, by
immediately getting rid of competition, it can charge the monopoly price right
away, without having to suffer the losses of a (possibly long) predatory phase.
The future discounted value of the post-­takeover profits is surely larger than that
24   The economics of predatory pricing
of the post-­predation profits. By granting the rival a fraction of these additional
monopoly profits, the leader will be certain to pocket the rest. That fraction may
go from zero to one. The latter figure corresponds to the maximum takeover
price, when the leader bestows upon its rival the entire extra profits. This is an
unlikely outcome. The leader will often acquire the rival by offering it a price
very close, possibly equal, to the minimum, especially if it may accompany this
proposal with a credible predatory threat.
Once again, the Chicago argument aims at demonstrating that PP is a non-­
rational strategy that will never take place in the real world and which, therefore,
requires no policing by antitrust law. Once again, the argument is open to criticism. Beyond the usual caveats concerning the alternative strategy’s rationality
and information requirements, a key objection is that a so-­called merger-­tomonopoly (i.e., a takeover by the market leader of its only competitor) is an even
more flagrant violation of §2 of the Sherman Act than PP.10 The law prohibiting
monopolization would be applied even more forcefully against such a takeover
than against PP – if only because, while price predation may always be disguised
as a competitive price cut, it is much harder for defendants to justify a merger-­
to-monopoly.
In conclusion, neither the basic story nor the Chicago critiques are fully convincing, theoretically speaking. Both suffer from over-­simplifications and an
idealized characterization of competition between a market leader and its rivals.
Key elements of real-­world predatory episodes are missing, first among them the
necessary strategic character of any such business behavior. With the benefit of
hindsight, we now know that cutting prices below cost may find its rationale in
sending a message to future rivals, rather than in “killing” existing ones – the
message being: “this is my market, don’t try to enter it, ’cause I’m ready to
squander bags of money to defend it.” Messages of this kind will represent the
core of the next generation of PP stories, explicitly based on game-­theoretic
Still, the controversy between the basic story and its Chicago critics may
teach a useful lesson. It casts light on the two poles of the century-­long debate
about PP. On the one side, a reasonable argument showing, though often too
naïvely, that predatory behavior may well be explained within a price-­theoretic
framework. On the other, a series of critiques that, regardless of their intrinsic
robustness, deserve credit for having revealed the worst danger of too restrictive
a policy against price cuts by dominant firms – namely, the danger of chilling
genuinely competitive behavior. Cutting prices is the competitive strategy par
excellence, the one that every antitrust enforcer should enhance and protect. The
Chicago critiques warn us that preventing big firms from cutting their prices
means depriving them of their most pro-­competitive weapon. Indeed, distinguishing between pro-­competitive and anti-­competitive price cuts is one of the
most – if not the most – difficult task for antitrust enforcers. The clash between
the basic story and Chicago is an acute reminder of this simple fact.
The economics of predatory pricing   25
4 It’s a brand new game: predation as strategic paradox
The development of strategic models of PP in the early 1980s was a landmark
event in the history of modern game theory. These were among the earliest
models where the new techniques and solution concepts of Bayesian game
theory (BGT) were applied to analyze games without the traditional assumptions
of perfect and complete information.11 Until the late 1960s, these unrealistic
assumptions had undermined the applicability of game theory to real worlds
problems, including IO ones. Explaining the late 1970s/early 1980s game theory
boom within neoclassical economics would exceed this book’s limits. But none
can doubt that the game theorists’ new ability to handle more realistic games
with either imperfect or incomplete information played a key role in the development of modern economics. Both the rise of modern information economics
(including mechanism design theory) and the establishment of game theory as
the core of mainstream microeconomics (a result the first generation of game
theorists had missed) descended from this technical improvement.12
Two names stood behind this chain of events, Reinhard Selten and John Harsanyi, both recipients of the 1994 Nobel Prize in Economics, together with John
Nash. Harsanyi taught game theorists how to deal with games of incomplete
information, where players lack some information about the game’s structure.
He suggested turning such games into games of imperfect information, defined
as games where players make at least one of their moves without being fully
informed about the previous moves made by other players. The trick that allows
the transformation lies in assuming that a fictitious player, called Nature, randomly selects a player’s “type,” i.e., a specification of the player’s relevant characteristics. As a consequence of Nature’s choice, the other players’ uncertainty
and lack of information may then be captured by their beliefs over the probability distribution of that player’s types – that is, by a kind of mathematical
object, subjective beliefs, which game theorists may handle with standard Bayesian tools. Hence the name Bayesian games for this class of models à la Harsanyi. The solution concept for these games is the so-­called Bayesian Nash
equilibrium, an extension of the standard Nash equilibrium to the agents’ beliefs
over the distribution of types.13
Selten’s role is even more crucial for our story. Beyond contributing on the
technical side with the development of backward induction and (subgame)
perfect equilibrium, the German mathematician was responsible for drawing
game theorists’ attention to PP. In his classic 1978 paper, “The Chain Store
Paradox,” he demonstrated that in a finite game under complete and perfect
information a predatory strategy is never part of the game equilibrium, i.e., that
PP is a behavior no strategically rational firm would ever undertake.
It is essential to understand what Selten’s result actually meant. The 1978
paper was neither about PP nor, more generally, about any other IO problem.
The story of the chain store having to decide whether to behave aggressively or
cooperatively in the face of potential entry was just an “expositional device
[that] should not be misunderstood as a model of a real situation” (Selten 1978,
26   The economics of predatory pricing
127).14 Selten’s main point was to compare two possible methods for solving the
chain store dilemma: that dictated by rigorous strategic reasoning, the induction
theory, and that suggested by sheer common sense, the deterrence theory. Backward induction showed that it would never be rational for the chain store to be
aggressive against entry. Cooperative behavior would prevail and entry would
always take place at every stage of the game. A theorem proved that this was the
only kind of behavior consistent with the new notion of perfect equilibrium.
Alternatively, deterrence theory required the chain store to behave aggressively
in a certain number of initial stages (i.e., cutting prices against the first n entry
threats) and shift to cooperative behavior only in later stages. The rationale was
that of “teaching a lesson” to future potential entrants by punishing those who
first tried to invade the chain store’s market. Such a theory sounded more reasonable that the previous one. Selten made the point emphatically:
The deterrence theory is much more convincing. If I had to play the game in
the role of player A, I would follow the deterrence theory. I would be very
surprised if it failed to work. From my discussions with friends and colleagues, I get the impression that most people share this inclination. In fact,
up to now I met nobody who said that he would behave according to the
induction theory. My experience suggests that mathematically trained
persons recognize the logical validity of the induction argument, but they
refuse to accept it as a guide to practical behavior.
(132–3)
Alas, what looked reasonable was also strategically inconsistent: “The deterrence theory fails to be game-­theoretically correct since it is incompatible with
the concept of a perfect equilibrium point” (156). The clash between rigor
and reasonableness (“The fact that the logical inescapability of the induction theory fails to destroy the plausibility of the deterrence theory” (133)) justified, in Selten’s view, describing the situation as a paradox – the chain store
paradox (CSP).
The message of the 1978 paper was clear. Induction theory only held under
the assumption of perfect and complete information, that is, the assumption that
players have all the necessary information required to make their rational moves.
If this extreme assumption was not met, deterrence theory remained the only
reasonable possibility. From the viewpoint of antitrust law, the right way to
interpret the CSP was that predation could well be a serious problem, precisely
because the only case where it was not so was the unrealistic setting where
induction theory held. Selten’s result sounded like an invitation to investigate
whether it would be possible to provide a formal underpinning to deterrence
theory, i.e., to the possibility for PP to be rational behavior. Researchers accepting Selten’s challenge could follow two paths: either analyzing more deeply the
firms’ decision-­making process or building new versions of the PP game with
(just a little bit of ) imperfect/incomplete information. In both cases, the fact that
Selten had casually chosen price predation to exemplify his argument provided
The economics of predatory pricing   27
an incentive to remain faithful to the PP setup. In short, PP became the chosen
narrative for a stream of seminal papers that would revolutionize game theory –
and with it also IO.
Before examining this literature, we may ask why, Selten’s lead notwithstanding, predation stories were such a fertile ground for 1980s Bayesian game theorists. Since the postwar years, IO problems in less-­than-perfectly competitive
markets have always represented the most natural setting for game theory. But
why PP (an instance of dominant firm behavior) in particular, rather than more
obvious selections, like, say, oligopoly or collusion? As the next chapters show,
two complementary answers can be given.
We already know the severe critiques that Chicago scholars raised against the
basic PP story. The earliest Chicago attack came from McGee (1958). This paper
had a tremendous impact on antitrust economics, far beyond the limited field of
PP, and came to epitomize the methodology of Chicago antitrust. In the words of
John McGee’s 1980 reassessment of his own contribution, one of Chicago’s
central ideas was that: “if they are to be broadly applicable, theories of business
behavior should concentrate on policies that pay” (McGee 1980, 295). His 1958
paper showed that PP was not such a policy; as a consequence, price cuts should
be exempted from antitrust scrutiny. Starting from the late 1970s, Chicago antitrust ideas began to migrate, so to speak, from classroom to courtroom. They
quickly gained ground, becoming the main theoretical framework for antitrust
decisions, to the detriment of more traditional IO. Business behaviors which had
been previously declared per se unlawful were now sanctioned by Chicago-­
driven courts. It may thus be surmised that those early 1980s game-­theoretic
models proving that McGee was wrong and that PP could well be a rational
strategy were a reaction against the new judicial trend. The policy implication of
the new models was that antitrust law should not automatically sanction every
price cut because some of them could well represent unlawful exclusionary
behavior. In short, one possible explanation for the popularity of PP among
game theorists is that it constituted the main battlefield for those who wished to
challenge the rise of the Chicago approach to antitrust.
The following chapters also show that, stimulated by McGee’s critiques,
several industrial economists had already highlighted the intertemporal and strategic character of PP well before 1980. While their arguments lacked the rigor of
later game-­theoretic models, those authors had built sophisticated narratives that
went beyond the basic PP story to show that rational firms could well undertake
predatory strategies. Notions such as threat, signaling, reputation, credibility,
etc., which would later represent the pillars of the game-­theoretic approach,
first entered IO in the 1960s and 1970s through these (largely informal) narratives of predation. Even the very notion of “cut price now to earn more profits
tomorrow” had already been interpreted, albeit informally, in terms of a
sequence of actions by the predator and its victim(s), each based on a firm’s
knowledge and expectations about its rival’s characteristics and behavior. Thus,
the post-­McGee literature constituted fertile ground for the later, more rigorous
models. “All” Bayesian game theorists had to do was to formalize these ideas by
28   The economics of predatory pricing
transforming the available PP stories into rigorous renditions of the firms’
actions and beliefs.
Linking these two explanations is the further observation that PP offered
game theorists an ideal environment in which to give concrete import to what
would otherwise appear as purely abstract models, totally detached from real
world problems. In other words, if you were a 1980s Bayesian game theorist,
still striving to persuade the wider community of economists of the practical
relevance of your new analytical tools, the problem of predation represented a
good opportunity15 to score a few easy points. In particular, by focusing on
imperfect/incomplete information settings, Bayesian games seemed to have an
edge in terms of realism over the standard price-­theoretic model based on the
(often implicit) assumption of perfect/complete information.
5 The Stanford connection
The analytical challenge launched by Selten’s paradox was picked up by two
pairs of authors – Paul Milgrom and John Roberts, David Kreps and Robert
Wilson – who in 1982 published a series of papers that marked a breakthrough
in the analysis of entry deterrence and predatory behavior and, more generally,
of every IO issue. Three of the four economists were (and still are) affiliated
with Stanford Graduate School of Business; the most senior of them, Bob
Wilson, has been in the GSB faculty since 1964. The fourth, Milgrom, was a
Stanford PhD graduate and future (since 1987) professor. Hence, the development of Bayesian games of PP, which have played so big a role in shaping contemporary IO, carries a distinctive Stanford GSB label.
The landmark papers by the Stanford Four were Milgrom and Roberts
(1982a) and (1982b) and Kreps and Wilson (1982). After this first outflow of
works, a flood of game-­theoretic literature followed in other branches of IO. By
the end of the 1980s, the entire field had been thoroughly redesigned according
to modern game-­theoretic tools, methods and ways of reasoning. The term
“modern” is synonymous with “à la Harsanyi-­Selten”: the Stanford Four’s
games were Bayesian games under conditions of imperfect/incomplete information. The triumph of game theory, which fulfilled after more than 40 years the
promise of von Neumann and Morgenstern’s Theory of Games and Economic
Behavior,16 was certified by the publication in 1989 of the Handbook of Industrial Organization (Schmalensee and Willig 1989), a magnum opus and fundamental reference in which game theory was simply ubiquitous. The 1982 papers
by the Stanford Four also stand at the origin of the game-­theoretic approach to
antitrust economics, the analytical backbone of so-­called Post-­Chicago antitrust
law and economics, i.e., of the approach that in the last quarter century has challenged the Chicago dominance in antitrust classrooms and courtrooms (see
below, Chapter 8).
The economics of predatory pricing   29
5.1 Signaling the limit
According to Milgrom’s “Predatory pricing” entry in the New Palgrave, the idea
common to the three foundational papers was that in a realistic setup of less than
perfect information, a firm endowed with market power may try to discourage a
competitor from entering or remaining in the market by manipulating the competitor’s beliefs (Milgrom 1988, 937). The idea was first developed by Milgrom
and Roberts in their 1982 Econometrica analysis of the cognate theme of limit
pricing.17
Economist James Friedman had demonstrated in 1979 that a result equivalent
to Selten’s 1978 theorem for PP also held for limit pricing. In a complete
information setting, post-­entry profits, and therefore the entry decision itself,
were independent of the pre-­entry price;18 hence, any attempt at limit pricing
would only squander part of the leader’s pre-­entry profits. Friedman had concluded that limit pricing could never be equilibrium behavior (Friedman 1979,
253). Once again a conflict arose between reasonableness and the logic of
complete inform