Price Leadership

In many industries under oligopoly, there may be no formal agreement to keep the prices at the same level or change them by the same amount. However, there is an implicit agreement among the oligopolists to keep the prices at the same level or change them by the same amount. The price leader is usually a dominant firm holding larger market share. For instance, in 1950s and 1960s, IBM was considered a price leader in the computer industry. Price leadership may be possible even among equals for example, in one instance Coca Cola may take the lead in another Pepsi Cola may take the lead. Price leadership is possible under both product differentiation and product homogeneity. Prices may differ due to product differences or cost differences. Effective price leadership refers to stable prices and price discipline. Effective price' leadership can exist under certain conditions.

(i)      Number of firms is small,

(ii)     There are restrictions to entry,

(iii)    Products are homogeneous,

(iv)    The demand for industry is inelastic or is very low, and

(v)     Cost functions of firms are almost similar. 

Dominant firm price leadership- Some markets have a single large firm which has acquired dominant position either due to scale economies or superior management skill. A dominant firm has significant market power that it can exercise over other firms in the industry, often called fringe firms or the competitive fringe. Stigler (1968) suggested a market share of 40% or more was required for a firm to be considered dominant and if the second firm in the industry were large, the required market share would be even higher. Other economists have suggested market share between 30 and 60 per cent.

Dominant firm maximises its profits according to the residual demand and the price-taking fringe firms produce along their supply curve at that price. Small firms act as price takers as in perfect competition. If these firms can sell all they produce at the market price, they maximise profits by producing until P = MC The model gives rise to First Mover Advantages and was introduced by Stackelberg in 1934. The dominant firm will earn higher profits as it sets its production at a high level. Intel and Microsoft are considered to be the leader companies in the computer industry (computer chips and software). They first announce the introduction of a new product in the market, and then the rest of the companies in the industry follow on their own.

Barometric price leadership: There may not be a dominant firm that sets the price each time. Barometric price leader may evolve if a firm changes price only in response to a change in market conditions. One firm may take the lead in announcing price hike due to higher costs which other firms are likely to follow as it reflects industry-wide cost changes. If the leader has misjudged the economic forces, the other companies may not change their prices or may affect changes of a different possibly lesser magnitude. In some instances, the price leader may have to retract prices or a series of iterations may be set in motion until a new price agreeable to all is achieved. Such a pattern is observed in industries like automobiles, steel, and paper.

Price leadership by low cost firm: Suppose all firms face identical revenue curves and different cost curves. Scale economies may lead to low costs of a firm. 

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