Question

1. Explain briefly the meaning of price leadership model in oligopoly market?

Answer 1

Price leadership is a form of co-ordinated behavior of oligopolists one firm sets the price and the others follow it because it is advantageous to them or because they prefer to avoid uncertainty about their competitors' reactions even if this implies departure of the followers from their profit-maximising position. Price leadership is widespread in the business world. It may be practised either by explicit agreement or informally. In nearly all cases price leadership is tacit since open collusive agreements are illegal in most countries. Price leadership is more widespread than cartels, because it allows the members complete freedom regarding their product and selling activities and thus is more acceptable to the followers than a complete cartel, which requires the surrendering of all freedom of action to the central agency. If the product is homogeneous and the firms are highly concentrated in a location the price will be identical. However, if the product is differentiated prices will differ, but the direction of their change will be the same, while the same price differentials will broadly be kept.

Most common type of leadership is price leadership by a dominant firm. In this model it is assumed that there is a large dominant firm which has a considerable share of the total market, and some smaller firms, each of them having a small market share.

The dominant firm leader maximises his profit by equating his marginal cost to his marginal revenue, while the smaller firms are price-takers, and may or may not maximise their profit, depending on their cost structure. Markets for steel and agricultural implements have been observed to operate in this manner.

The theory of price leadership represents a combination of monopoly behavior on the dominant firm’s part and perfectly competitive behavior on the part of following firms. In the price leadership model, only the dominant firm has monopoly power — only the dominant firm can set price.