Predatory Pricing, Tariffs, and the Second Law of Demand

Predatory pricing is a common justification for government intervention in a marker (predatory pricing is when a firm or government tries to gain monopoly power in a market by selling below cost, undercutting competitors and forcing them out, and then raising prices to a monopoly level.  For a great treatment of predatory pricing, see here).

On a recent Cafe Hayek post, Craig Walenta (friend of the blog) objected to a lack of concern vis-a-vis Chinese dumping thusly:

 Of course that which is seen, but that which is unseen are the incidental effects because this absolutely must be incorporated into your business judgment, or you’d just be a complete idiot, and you’re not going to have any sense of what the unseen is unless you actually own a business and talk to other business owners who will tell you that the general rule is that ‘if it can be done in China, EVEN IF IT CAN BE DONE HERE CHEAPER, don’t do it’ — indeed foreign and domestic favoritism clearly impacts businesses that have absolutely no relation to the favored industries in question.
Mr. Walenta’s concern is legitimate.  Why would business owners compete in a market if someone is going to undercut them?  There may be people who do not enter some industry for fear of competition.
But does that mean China can, once they receive monopoly power, can raise and keep prices high with the mere threat of undercutting prices again?  Not likely, because of the Second Law of Demand.
The Second Law of Demand is, to quote Armen Alchian and William Allen (Page 28):
[T]he longer the time allowed to adjust amount demand in response to a price change, the greater is the change in amount demanded, that is, the greater the elasticity…For example, if the price of water were doubled, consumption would immediately decrease some–but would decrease by a great deal more within a few months, after people had more economically made adjustment to their water-using equipment[.]
In other words, people initially make little adjustments to a rise in prices but the longer prices stay high, the bigger their adjustments become.  To stick with the water example, if the price of water spikes quickly, people may water their lawn less or wash their car less, but that’s about it.  If the price of water stays high, people may rip out their lawns and go for rock gardens (eg, Arizona), may shower together to save water, may move to disposable plates rather than washable dishware, etc.
To bring this back to China, if China were to gain a monopoly power and raise prices, even if they were to maintain their monopoly power with the mere threat of lower prices, it is unlikely they would succeed.  At first, they may be able to command monopoly prices, but the high price of steel will eventually force people into different areas: maybe more plastic is used for automobiles than steel.  Maybe wood and brick replace architectural steel.  Maybe some new metal alloy is created to replace steel, or there are shifts to titanium or something like that.  Maybe someone develops a super-lightweight but super-strong material that renders steel obsolete (like Kevlar for buildings).  It’s impossible to know what path things would take.  What we do know is the Law of Demand says that people will adjust, and thus it is highly improbable anyone who gains monopoly power through predatory pricing will be able to maintain monopoly profits.

5 thoughts on “Predatory Pricing, Tariffs, and the Second Law of Demand

  1. This is a family blog.

    Well, of course it is. I can only suggest that showering together may not be as effective a method of saving water as one might think. In my own very limited experience of showering with other people, the amount of water used seemed to be much greater than the amount the same two people typically used when showering separately, perhaps because this dual shower also took much longer than two individual showers. The worst part is that neither party seemed concerned at all by the horrendous waste of Earths precious resources.

    Until further study clarifies this apparent paradox and definitively proves that showering together saves water, I would recommend against it as a water saving measure.


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