Predatory pricing is one of the most interesting and most controversial issues in antitrust. The term refers to a practice whereby an incumbent firm (the predator) sets prices very aggressively with the aim of excluding a rival from the market (that is, forcing the rival to leave the market or discouraging it from entering) or marginalising the rival and relegating it to a niche role. Predation -if successful -will therefore be associated with the existence of two periods: one, the predatory period, in which consumers will enjoy low prices and the incumbent will sacrifice profits; the other, the recoupment period, in which the incumbent will be able to increase its prices, and obtain higher profits, because the prey is no longer in the market (or has been marginalised). From the incumbent's point of view, this strategy is profitable if the earlier profit sacrifice is outweighed by the subsequent higher gains. From the point of view of consumers, and of social welfare, exactly the opposite happens. If the predatory strategy is successful, higher surplus during the predatory period will be outweighed by lower surplus in the recoupment phase.Given that predatory episodes are associated with low prices, it should not come as a surprise that it is extremely difficult to distinguish low prices that are an expression of tough but fair competition from low prices that are an expression of an exclusionary strategy by the dominant firm. Suppose we observe that after the entry of a competitor, an incumbent firm reacts by starting to cut prices aggressively. Is this the sort of genuine competitive response that we should expect (after all, any theory in which firms do not collude would foresee that entry would lower equilibrium prices), or is it instead predation? In other words, are low prices good news for consumer welfare, or are they instead just a temporary consumer 14
Both the academic literature and the policy debate on systematic bailout guarantees and Government subsidies have ignored an important effect: in industries where firms may go out of business due to idiosyncratic shocks, Governments may increase the likelihood of (tacit) coordination if they set up schemes that rescue failing firms. In a repeated-game setting, we show that a systematic bailout regime increases the expected profits from coordination and simultaneously raises the probability that competitors will remain in business and will thus be able to "punish" firms that deviate from coordinated behaviour. These effects make tacit coordination easier to sustain and have a detrimental impact on welfare. While the key insight holds across any industry, we study this question with an application to the banking sector, in light of the recent financial crisis and the extensive use of bailout schemes.
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