Q1 Q2 Q3 Q4 Q5 Quantity per time period

units of output, leaving demand of Q5 - Q2 for the price leader. Plotting all of the residual demand quantities for prices below P3 produces the demand curve for the price leader, DL in Figure 11.5, and the related marginal revenue curve, MRL.

More generally, the leader faces a demand curve of the following form:

f barometric price leadership

A situation in which one firm in an industry announces a price change in response to what it perceives as a change in industry supply and demand conditions and other firms respond by following the price change where DL is the leader's demand, DT is total demand, and S, is the followers' supply curve found by setting P = MCf and solving for Q, the quantity that will be supplied by the price followers. Because DT and Sf are both functions of price, DL is likewise determined by price.

Because the price leader faces the demand curve DL as a monopolist, it maximizes profit by operating at the point where marginal revenue equals marginal cost, MRL = MCL. At this optimal output level for the leader, Q1, market price is established at P2. Price followers supply a combined output of Q4 - Q1 units. A stable short-run equilibrium is reached if no one challenges the price leader.

A second type of price leadership is barometric price leadership. In this case, one firm announces a price change in response to what it perceives as a change in industry supply and demand conditions. This change could stem from cost increases that result from a new industry labor agreement, higher energy or material costs, higher taxes, or a substantial shift in industry demand. With barometric price leadership, the price leader is not necessarily the largest or the dominant firm in the industry. The price-leader role might even pass from one firm to another over time. To be effective, the price leader must only be accurate in reading the prevailing industry view of the need for price adjustment. If the price leader makes a mistake, other firms may not follow its price move, and the price leader may have to rescind or modify the announced price change to retain its leadership position.

kinked demand curve

A theory assuming that rival firms follow any decrease in price in order to maintain their respective market shares but refrain from following increases, allowing their market share to increase at the expense of the firm making the initial price increase

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