Understanding Limit Price Strategy

The limit price is a specific pricing strategy used by firms, particularly in markets with potential new entrants (like oligopolies).

Its primary goal is to deter or prevent the entry of new firms into the market. This is achieved by setting a price low enough that potential competitors perceive the market as unattractive due to low potential profits.

Analyzing the Options

• Option 1 (Profit Maximization): While firms aim for profits, the limit price is often set below the short-run profit-maximizing level to achieve a long-term strategic goal (market dominance and preventing entry).
• Option 2 (Preventing Entry): This correctly defines the core purpose of a limit price. It acts as a barrier to entry.
• Option 3 (Earning Surplus): Earning a surplus (profit) is a general business objective. The limit price focuses on the level of surplus that discourages new entrants, which might be minimal or zero economic profit.
• Option 4 (Maximum Allowed Price): This sounds like a price ceiling regulated by an authority, not a strategic choice made by the firm itself.

Therefore, the definition aligning with the strategic use of pricing to maintain market control is that the limit price is the price which prevents the entry of new firms.