Limit pricing is a technique of setting the price mainly used by the monopolist for discouraging entry of the new firms in the market. In this way the monopolist can increase his price and the level of supernormal profit. The price of the product or the service will therefore be at the level which is just below the potential entrants to use the market.
Basic Strategic Model of Limit Pricing
To obstruct the entry of the potential competitors, the company should set the price lower than the market rate. On the spot rationality will prevail in this case with the help of the modern Economics. In this model, the seller determines the price assuming that the other sellers will keep their price same as previous. You can clearly observe the reasonable predictions of the price-cost margins and the cost effect changes in the industry.
Advantages of Limit Pricing
Limit pricing will help in decreasing the competition. The low limit price will always encourage staying in the market as a monopolist company without new entries of the competitors.