IAI Actuarial Core Principles · Business Economics · Pricing strategies in the financial services sector

A dominant Indian mutual fund house sets its expense ratio at a level just below the long-run average cost of a potential new entrant, even though it could earn higher profit at a higher price. What is the main aim of this limit pricing?

The aim is to deter entry. By pricing just below what a new entrant could profitably charge, the incumbent makes entering unattractive, sacrificing some short-run profit to protect its long-run market position.

ATo make entry unprofitable and deter new competitorsCorrect
BTo drive existing rivals out and then raise prices
CTo maximise short-run profit in the current period
DTo segment customers by willingness to pay
To recover development cost quickly from early adopters

Explanation

Limit pricing sets price low enough that a new entrant cannot cover its costs, so entry is deterred, while the incumbent still earns some supernormal profit. It differs from predatory pricing, which targets existing rivals and typically involves losses. It is not short-run profit maximisation, since a higher price would earn more now.

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