PRICE LEADERSHIP MODEL IN MONOPOLISTIC COMPETITION

PGDM-BAPGDM-BAII SemesterII SemesterBatch 2009-11Batch 2009-11

Monopolistic competition is a market structure in which

there are many sellers of a commodity, but the product of

each seller differs from that of the other sellers in one respect or the other.

MONOPOLISTIC COMPETITION

Large no. of Firms &Buyers.

Free Entry & Exit.

Product Differentiation.

Independent Pricing

Features Of Monopolistic Competition

Price Leadership

The Price-Leadership

Price leadership occur when specific firms in a group set a price that subsequently determines what other members of the group will change.

The Price-Leadership ModelAssumptions

1. The industry is made up of one large firm and a number of smaller, competitive firms;

2. The dominant firm maximizes profit subject to the constraint of market demand and subject to the behavior of the smaller firms;

3. The dominant firm allows the smaller firms to sell all they want at the price the leader has set.

The Price-Leadership ModelOutcome

1. The quantity demanded in the industry is split between the dominant firm and the group of smaller firms.

2. This division of output is determined by the amount of market power that the dominant firm has.

1. has a big cost advantage over the other firms.

2. sells a large part of the industry output.

3. sets the market price (price maker)

A dominant firm may exist if A dominant firm may exist if one firmone firm

The Dominant Firm Model

DD is the market demand curve, and is the market demand curve, and SSFF is the is the

supply curve (i.e., the aggregate marginal supply curve (i.e., the aggregate marginal cost curve) of the smaller fringe firms.cost curve) of the smaller fringe firms.

The dominant firm must determine its The dominant firm must determine its demand curve demand curve DDDD. As the figure shows, this . As the figure shows, this

curve is just the difference between market curve is just the difference between market demand and the supply of fringe firms.demand and the supply of fringe firms.

At price At price PP11, the supply of fringe firms is just , the supply of fringe firms is just

equal to market demand; thus the dominant equal to market demand; thus the dominant firm can sell nothing. At a price firm can sell nothing. At a price PP22 or less, or less,

fringe firms will not supply any of the good, fringe firms will not supply any of the good, so the dominant firm faces the market so the dominant firm faces the market demand curve. demand curve.

At prices between At prices between PP11 and and PP22, the dominant , the dominant

firm faces the demand curve firm faces the demand curve DDDD..

Price Setting by a Dominant Firm

The Dominant Firm Model

The dominant firm produces The dominant firm produces a quantity a quantity QQDD at the point at the point

where its marginal revenue where its marginal revenue MRMRDD is equal to its marginal is equal to its marginal

cost cost MCMCDD. .

The corresponding price is The corresponding price is PP*.*.

At this price, fringe firms At this price, fringe firms sell sell QQFF

Total sales equal Total sales equal QQTT..

Price Setting by a Dominant Firm

Price leadership by a dominant firm

SMCd

ΣSMCs

($) F

Quantity( Q)

Price

0 2 4 6 8 10 12G

mrd2

BC

12 A

HK L

E

76J

Thank You

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