Introduction

Why might a firm sell its product at prices less than marginal cost? If each firm posts its price in advance of learning its demand, the quantity demanded could exceed the maximum quantity a firm wishes to supply when competitors charge higher than expected prices or demand is strong. Such a firm then faces a choice of whether to ration its customers or to serve all demand. There are many reasons why a firm might forgo the strategy of short-run profit maximisation and serve all demand. Among them are encouraging shopping by consumers who buy both advertised and unadvertised goods, maintaining a positive reputation with consumers, and inducing risk-averse consumers with significant shopping costs to seek out low prices by removing the risk of finding the store stocked out.

Some firms effectively commit to serve all demand by offering ‘rainchecks’. Many supermarket chains in the United States issue coupons to consumers to buy items advertised at special prices when the super-market runs out of its supply. The consumer can then return after the store restocks and obtain the product at the special price. Trade deals with manufacturers often enable stores to offer special low prices, so offering to sell the good after the sale period at the low price is an offer to sell at a price below marginal cost. While maintaining goodwill is an obvious explanation, there are at least two others. First, the Federal Trade Commission (FTC) regulates advertising.