Lower efficiency: Some economists argued that there is a low level of production efficiency in oligopoly. Naturally, other firms follow him willingly. A change in the price of oil will often lead to all firms changing prices by a similar amount. This is reinforced in situations where the customers understand the cost model. Drawbacks of Price Leadership : The price leadership suffers from various drawbacks. In some oligopolies, there may be an element of price leadership. The following firms produce an aggregate of 1,500 units.
Sometimes a large dominant firm will act as a natural leader. If a firm decides to charge Rs. Hence, the dominant firm also becomes the price leader. In the price leadership model of oligopoly: The dominant firm sets its output level so as to keep the price in the industry high enough for all firms to earn excess profits. Firms in an oligopoly do not often change prices, certainly not for minor changes in costs, but they will change prices if cost changes are substantial.
Price-Output Determination under Low-Cost Price Leadership: Economists have developed various models concerning price-output determination under price leadership making different assumptions about the behaviour of price leader and his followers. Economists measure the economic harm from insufficiency in terms of the deadweight loss; this term signifies the loss in real income that arises because of monopoly, tariffs and quotas, taxes, or other distortions. Another factor that increases cheating is recessions. A leader may set quantity. In oligopoly such a practice is possible. This is calculated by looking at where the perfectly competitive firms marginal cost curve crosses the industry demand curve which occurs at point 'C'. Different economists have developed different models for determining price and output in price leadership.
But there is an important difference between the two. This represents the sum of the individual marginal cost curves for each of the firms participating in the perfectly competitive side of this market. Naturally other firms follow it willingly. In other words, demand curve facing each firm will be the same and will be half of the total market demand curve of product. The other major barrier to collusion is. There are a number of oligopolistic organizations in the market, but one of them is dominant organization, which is called price leader.
This creates a kink in the demand curve, where the change in demand goes from very elastic at higher prices to inelastic at lower prices. Price leadership is an important form of collusive oligopoly. Moreover, a high price fixed by the price leader will attract new competitors into the industry which may not accept his leadership. For example, in 2012, Apple was accused of colluding with e-book publishers to artificially inflate product prices. However, price wars are self-limiting, since they will often lead to losses. If it lowers its price, then the other firms will match the lower price, causing all the firms to earn less profit. Small output and high prices: As compared with perfect competition, oligopolist sets the prices at higher level and output at low level.
The number of firms in the industry may be two or more than two but not more than 20. The oligopolists push non-price competition beyond socially desirable limits. Price leadership by the leading organization is most commonly seen in the industry. It is often noticed that there is stability in price under oligopoly. When the number of organizations is small ii. Readers Question: To what extent does the kinked demand curve model explain price rigidity in oligopoly? Price Leadership Model: Under price leadership, one firm assumes the role of a price leader and fixes the price of the product for the entire industry. A dominant firm is one which has a large capacity to produce and sell in the market.
Markets for steel and agricultural implements have been observed to operate in this manner. Aggressive Price Leadership: Implies a leadership in which one organization establishes its supremacy by threatening the organizations to follow its leadership. One common obstacle is differences in demand and cost. In order to simplify our analysis we make the following assumptions: 1 There are two firms, A and B. As trade barriers fall, oligopolies find they must compete with oligopolies from other countries, which diminishes their pricing power. Therefore, for a price cut, demand is price inelastic. Two firms have to charge the same price in order to survive in the industry.
Technology can also diminish the pricing power of oligopolies by producing better products, by lowering the fixed costs of developing a product, and by opening markets to more competitors. Some skeptical economists retort that monopolists mainly promote the quiet life, poor quality and uncivil service. Here, we would discuss a simple model for determining price and output in price leadership, which is shown in Figure-4: Suppose there are two organizations, A and B producing identical products where organization A has a lower cost of the production than organization B. The collusive model occurs when a few dominant firms agree to keep their prices in mutual alignment. In circumstances of low inflation, they may be reluctant to change or they may wait and move to another significant price like £10. Price Determination under Price Leadership: There are various models concerning price-output determination under price leadership on the basis of certain assumptions regarding the behaviour of the price leader and his followers. The purple Ddf line represents the demand curve for the dominant firm.
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. Price leadership serves another important purpose. The joint action of the few big firms discourages the entry of new firms into the industry. The follower seeks to maximise profits: This means that the follower will want to choose an output level where price equals marginal cost. Price-Output Determination under Price Leadership by the Dominant Firm: We now proceed to explain the determination of price and output when there exists price leadership by a dominant firm which is having a large share of the market with a number of small firms as followers each of which has a small share of the market. Another possible barrier to collusion is that if prices are maintained too high, then it may allow new entrants into the industry that will provide more competition, or, smaller firms that did not have much market power can cut prices and increase production to grab market share.