is why it is more acceptable to the followers than a complete cartel

which demands surrendering of all freedom of action to the central

agency.

There are various forms of price leadership. The most common

types are :
1. Price-leadership by a low cost firm
2. Price-leadership by a dominant firm
3. Barometric price leadership.

2.2.1. Price-leadership by a low cost (efficient) firm : In this

model, it is assumed that there are two firms in the industry : their
products are homogeneous ; one firm is more efficient and hence
its costs are lower than those of the other; each firm is allocated
half the marks share according to the tacit market- sharing
agreement. In Fig. 2.1, DD is the market demand curve and dd is
the demand curve facing each firm. SAC 1 and SMC2 are the
average and marginal cost curves of the efficient or low cost firm
while SAC2 and SMC2 are the average and marginal cost curves
of the less efficient or high cost firm. MR is the marginal revenue
curve facing each firm. The high cost firm would like to produce
OX2 output and charge OP price because it is at this output that
the firm's MR curve intersects SMC 2 curve. The low cost firm, on
the other hand, would like to produce OX 1 output and charge OP
price because it is at OX1 output that the MR curve intersects
SMC1. This is the profit-maximising output and price for the
efficient firm. It is evident that the low cost firm will dictate the
price and the high cost firm will be compelled to follow it. The
follower can obtain a higher profit by producing a smaller output
OX2 and selling it at a higher price OP2 (it is at this out put that its
MR SMC2) However, he prefers to follow the leader sacrificing
some of its profits in order to avoid a price war. Such a price war
can eliminate the high cost firm if price fell sufficient low as not to
cover its LAC. It should be noted that for the leader to maximise
his profit, price must be maintained at the level OP and he should
sell OX1 quantity. This implies that is assumed that each firm is
allocated half the market share, therefore OX 1 + X2 = OX, the
market demand.

Although this model of price leadership stresses the fact

that the leader sets the price and the follower accepts it, it is
obvious that the firms must also reach agreement on the sharing
of the market. If such an agreement is not reached, the follower
can accept the price of the leader but produce a quantity smaller
than that required to maintain the leader's price, and thus force
the leader to a non-profit maximising output. In this respect, the
follower is not completely passive.