Price Leadership

price leadership

A situation in which one firm establishes itself as the industry leader and all other firms in the industry accept its pricing policy

An informal but sometimes effective means for reducing oligopolistic uncertainty is through price leadership. Price leadership results when one firm establishes itself as the industry leader and other firms follow its pricing policy. This leadership may result from the size and strength of the leading firm, from cost efficiency, or as a result of the ability of the leader to establish prices that produce satisfactory profits throughout the industry.

A typical case is price leadership by a dominant firm, usually the largest firm in the industry. The leader faces a price/output problem similar to monopoly; other firms are price takers and face a competitive price/output problem. This is illustrated in Figure 11.5, where the total market demand curve is DT, the marginal cost curve of the leader is MCL, and the horizontal summation of the marginal cost curves for all of the price followers is labeled MCf. Because price followers take prices as given, they choose to operate at the output level at which their individual marginal costs equal price, just as they would in a perfectly competitive market. Accordingly, the MCf curve represents the supply curve for following firms. At price P3, followers would supply the entire market, leaving nothing for the dominant firm. At all prices below P3, the horizontal distance between the summed MCf curve and the market demand curve represents the price leader's demand. At a price of P1, for example, price followers provide Q2

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