Oligopoly

Price leadership Model

Types of price leadership

Types of price leadership
Price leadership by a low cost firm Price leadership by the dominant firm Barometric price leadership Exploitative or aggressive price leadership

Low cost firm

Price leadership by low cost firm
Assumptions
1. Each of the two firms has equal share in the market (demand curve facing each firm will be the same and will be half of the total market demand curve of product)

Each of the two firms has equal share in the market

D (Market demand) MR

d (Firm demand)

Q per year

Low cost firm

2. There are two firms, A and B. the firm A has a lower cost of production than B. 3. The product produced by the two firms is homogeneous so that the consumers have no preference between them.

$
MCb

the firm A has a lower cost of production than B.

MCa

ACb

P
ACa D (Market demand)

MR

d (Firm demand)

O Q per year

The firm A will maximize it's profit by selling output OM and setting price OP

MCa

ACa
D (Market demand)

MR

d (Firm demand)

Qtotal

Q per year

MCb

The firm B's profit will be maximum when it fixes price OH and sells output ON.
ACb MCa

ACa
D (Market demand)

MR

d (Firm demand)

N M

Qtotal

Low cost firm

Since the two firms are producing a homogeneous product, they cannot charge two different prices. Because the profit maximizing price OP of firm A is lower than the profit maximizing price OH of firm B, firm A will dictate the price to the firm B and will emerge as a price leader and firm B will follow.

Both firms will charge price OP and sell OM

MCb ACb MCa

ACa
D (Market demand)

MR

d (Firm demand)

Qtotal

Dominant firm

There exists price leadership by a dominant firm which has a large share of market with a number of smaller firms as followers each of them has a small share of market.

Assumptions
Dominant firm knows the total market

demand

Dominant firm knows the marginal cost of the smaller firms whose lateral summation yields the total supply by the small firms at various prices.

 MC (Supply of small firms)

$

Total Market demand

Q per year

Demand fulfilled by small firms $

MC
$

With these information, the leader can obtain his demand curve.

P1

D Leader demand

Q per year

Q per year

Demand fulfilled by small firms $

The dominant firm will maximize it's profit by selling output OQ MC and setting price OP
MC

P D

Leader demand
MR

Q per year O

Q per year

Dominant firm

Dominant firm have to ensure that the small firms will produce only the remainder of demand (not more) otherwise the dominant firm will be pushed to a non-maximizing position. This implies that if price leadership is to remain, there must be some definite market sharing agreement.

Barometric price leadership

All firms agree to follow the price change made by a firm which supposedly has good knowledge of the market conditions and thus can forecast future happening in the market better than others. Followers are not required to make continuous costs on demand calculations.

Aggressive price leadership

Dominant firm compel the other firms in the industry to follow him in respect of price. Such a firm will often initiate a move threatening to compete the others out of the market if they do not follow him in setting their prices.