4Low 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)
5Each of the two firms has equal share in the market $D (Market demand)d (Firm demand)MROQ per year
6Low cost firm2. 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.
7P the firm A has a lower cost of production than B. $ O Q per year MCb ACbMCaPACaD (Market demand)d (Firm demand)MROQ per year
8The firm A will maximize it's profit by selling output OM and setting price OP $MCaPACaD (Market demand)d (Firm demand)MROMQtotalQ per year
9The firm B's profit will be maximum when it fixes price OH and sells output ON. MCbACbMCaHPACaD (Market demand)d (Firm demand)MRNMQtotalO
10Low cost firmSince 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.
11Both firms will charge price OP and sell OM MCbACbMCaPACaD (Market demand)d (Firm demand)MROMQtotal
13Dominant firm Assumptions 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.AssumptionsDominant firm knows the total market demandDominant firm knows the marginal cost of the smaller firms whose lateral summation yields the total supply by the small firms at various prices.
14(Supply of small firms) $Total Market demandOQ per year
15Demand fulfilled by small firms With these information, the leader can obtain his demand curve.Demand fulfilled by small firms$$P1DLeader demandOQ per yearQ per year
16Demand fulfilled by small firms The dominant firm will maximize it's profit by selling output OQ and setting price OP$MCPPDLeader demandMROOQ per yearQQ per year
17Dominant firmDominant 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.
19Barometric 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.
21Aggressive 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.