Limit pricing under third-degree price discrimination

We consider an incumbent who operates in two independent markets and has private information about his production cost. In one of the markets, there is a potential entrant o¤ering a di¤erentiated product. The most reasonable perfect bayesian equilibrium is either the least cost separating equilibrium or the pooling equilibrium where both types of incumbents set the low cost monopoly prices. The equilibrium may involve a downward distortion in both markets pre-entry prices. This distortion is increasing with the discount factor, the degree of product substitutability and the e¢ ciency of the entrant. An implication of our model for international trade policy is that a lower price in the foreign market is neither a necessary nor a su¢ cient condition for the existence of entry deterrence in the foreign market. Keywords: Entry Deterrence, Product Di¤erentiation, Asymmetric Information, Discriminatory Pricing. JEL classi…cation: D40, D82, L11, L12, L13.