What is price leadership? Analyse the model of price leadership by a dominant firm.

Price leadership occurs when a firm in an industry, usually the largest or most powerful, takes the lead in setting prices for the industry. The dominant firm sets the price, and the remaining firms in the market follow by charging the same price or slightly lower without directly competing on price. This phenomenon usually occurs in oligopolistic markets where there are a few large firms dominating the industry.

Price leadership has some advantages for both the dominant firm and the industry as a whole. Some advantages include: a. Stability in prices: Price wars are avoided, resulting in stable prices for consumers. b. Lower costs: Firms may avoid the costs associated with price wars, allowing them to focus on other factors such as innovation and production efficiency. c. Increased profitability: The dominant firm may use its pricing power to generate higher profits while the smaller firms may gain some benefits from maintaining prices at a stable level.

Although there are advantages, there are also disadvantages to price leadership: a. Collusion concerns: Price leadership can potentially lead to antitrust concerns, as it may give the appearance of price-fixing or collusion among the leading firms. b. Reduced competition: When prices are primarily determined by a single firm, it can stifle competition and discourage innovation among smaller firms. c. Consumer disadvantage: When prices are maintained at higher levels, it may be disadvantageous for consumers who may have to pay a higher price for goods and services.

To analyze the model of price leadership by a dominant firm, we need to understand how the dominant firm determines its optimal price and output levels. The dominant firm sets the price by considering its own cost structure, as well as the market demand and supply of the remaining, smaller firms. a. Determine the dominant firm's marginal cost (MC): Calculate the dominant firm's MC, given by the derivative of the cost function with respect to output quantity. b. Determine the market demand curve (D): Obtain the market demand curve, which relates the total quantity demanded to the price. c. Obtain the supply curve of fringe firms (S_fringe): Calculate the supply curve for the smaller firms, considering the costs and demand they face at different price levels. d. Determine the residual demand curve (D_residual): The residual demand curve shows the quantity of goods the dominant firm needs to produce at each price level, given the supply of smaller firms (D_residual = D - S_fringe).

To determine the dominant firm's optimal price and output levels, we must find where the dominant firm's MC equals its marginal revenue (MR) from the residual demand curve: a. Calculate the MR from the residual demand curve: Determine the MR by taking the derivative of the residual demand curve with respect to the quantity of goods produced by the dominant firm. b. Set MC = MR: Equate MC to MR and solve for the output quantity. This will provide us with the optimal output level for the dominant firm. c. Determine the optimal price: Insert the optimal output level into the market demand curve or the residual demand curve to find the corresponding price. This will establish the optimal price at which the dominant firm should sell its products. By following these steps, we can analyze the model of price leadership by a dominant firm and determine the optimal price and output levels.