For simplicity let us suppose that there are only two firms A and B. If there are only 2 or 3 firms in the oligopoly, then it is fairly easy to collude to set prices or to limit competition. A company with a high reputation for quality may even be able to charge a premium and simply pockets a much larger profit margin than its competitors. Consequently, there is a great temptation for inefficient producers to cheat, and if they cheat, then price competition ensues. Another important difficulty of maintaining price leadership is the tendency on the part of the rivals to indulge in non-price competition to increase sales while go on charging the price set by the price leader. The new firms may not sell the same products but will sell similar products. Whatever the case may be, the firm, which sets the price, is the price leader.
Before extensive world trade, oligopolies developed independently in many modern economies. Dishtv customers can now get blessed at the press of a button in the comfort of their home 24X7. Barometric price leadership takes place due to the following reasons: a. Collusive Model In collusive price leadership, a few key firms all tacitly agree to keep their prices the same. Thus, price war leads to price rigidity or price stability in the oligopoly market.
Such agreements can be illegal if the effort is designed to defraud the public. The point 'B' represents the price level that would be attained if there was no dominant firm. It may be practiced either by explicit agreement or informally. This situation would then attract new firms in the market. Temptation of more profits and rivalry leads to independent pricing.
Cartel Model Sometimes firms in an oligopoly try to form a cartel by agreeing to fix prices or to divide the market among themselves, or to restrict competition some other way. In Dominant firm price leadership, the firm with the largest market share or monopoly sets the price of the product and other small firms act as the price-takers. The barometric model occurs when a particular firm is more adept at identifying shifts in applicable market forces, allowing it to respond more efficiently within the market sector. We now discuss price and output determination in the long run. This is the natural result of fewness.
This cost difference does not always translate into a lower price, though it can. It is this tacit agreement which usually a feature of price leadership. This is the situation corresponding to the long run and is discussed in the next section. About the Author Evangeline Marzec is a management consultant to small high-tech companies, and has been in the video games industry since 2004. Firms that serve different geographic markets will have varying levels of demand, and, in many cases, they will also have different efficiencies, resulting in different. Price leadership is widespread in the business world. .
In nearly all cases price leadership is tacit since open collusive agreements are illegal in most countries. The price-output determination is illustrated. It is quite popular in industries like cigarette industry. Lastly, differences in costs also pose a problem. Oligopolies, like monopolies and , also have excess capacity. However, it is much more difficult for an oligopoly to determine at what output it can maximize its profit.
This implies that both the organizations would face same demand curve, which further represents equal market share. Here any firm in the oligopolistic market can act as a price leader. If there are only two sellers, we have a duopoly. While charging the same price, the rivals try to increase their share of the market by increasing the advertisement expenditure. If the price leader has higher costs, then the high price fixed by him will, as mentioned above, induce the rivals to undercut price or will attract the entry of new firms into the industry.
This implies that the follower must supply a quantity 0X B in figure 10. Further, there is a great limitation on the price leader to fix a high price of his product. As a result, the industry evolved from dominant firm to barometric price leadership. A firm belonging to another industry may also be chosen as the barometric leader. As a result, there will be an increase in the number of close substitutes available in the market and hence the demand curve would shift downwards since each existing firm would lose market share. The quantity consumed Q equals q d plus q f.
There are three major types of price leadership, which are present in industries over a passage of time. Some of the ways include price, advertising, product quality, etc. But when there is difference in cost of production then cartel is unstable because the low cost firm will have the temptation to lower price to increase its profits. Price leadership is an important form of collusive oligopoly. One common obstacle is differences in demand and cost.