The theory of limit pricing: Some applications to the banking industry

This paper employs a probabilistic theory of limit pricing to examine a number of issues of bank behavior relevant to limit pricing. First, the circumtances under which an entry threat produces a procompetitive impact on prices are analyzed. In contrast to the single-product firm, unambiguous predictions are found to result only in rather special situations. Next, the theory is used to examine the conditions under which it is optimal for a bank to ration credit as a result of an entry threat, suggesting limit pricing as an alternative explanation for this phenomenon. Finally, the theory is employed to contrast the implications of limit pricing from that of a related concept (probable future competition) as they apply to bank merger policy.