Price Leadership

Price Leadership refers to a situation where the dominant firm sets up the price of goods or services in the market. It generally happens when the goods are homogeneous, i.e., there is no difference in the goods or services provided by different firms. Therefore, customers don’t have a preference and choose the lowest price. Such a model is usually seen in the Oligopolistic market, where competition is less.

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• Price leadership occurs when a dominant firm sets the price for goods or services in the market, typically in an oligopolistic market with homogeneous products. Customers have limited choices, often opting for the lowest price.
• Three types of price leadership exist: barometric, where the firm with the best market information sets the price; collusive, where firms collaborate to set prices collectively; and dominant, where the leading firm unilaterally sets the price.
• Price leadership is often used by a strong firm to establish its presence in the market. Following price leadership and avoiding price wars can benefit smaller firms. 

The optimal level of output and price is the point where the Marginal Cost Curve will intersect the Marginal Revenue curve. In the above Diagram, Company A is the leader, and Company B is a small firm in the same industry. As Company A is the leader, they have achieved economies of scale, and you can see that for this reason, the Marginal Cost line of A is below B.

The demand for both firms is the same in the economy with no product differentiation. So Marginal Revenue is also the same. Now Marginal Revenue of firm A is cutting the Marginal Cost at a much lower point. So the optimal output is “O,” and the optimal price is “P” for firm A. As the price is less than P1, which is optimal for Firm B; still firm B will have to follow price P instead of P1. It is price leadership by Firm A.

There are three types of price leadership:

#1 - Barometric

It is quick adaptable. Once a firm discovers a sudden efficient, cost-effective way of production due to research or discovery, it starts to follow it and reduces its prices. To compete with the firm, other firms start following the same production schedule and minimize price as the firm is not big enough, so the leadership is short-lived. Big firms soon take over the price.

#2 - Collusive

These are agreements formed by a few dominant firms in the market. Other small firms are forced to follow as they can’t win with the dominant firms. Price leadership mainly arises due to a reduction in operation costs, but this kind of arrangement is not legal if the public is not benefiting from the agreement.

#3 - Dominant

It is a kind of monopoly. It occurs in an economy where a single firm is large enough to dominate the market. The dominant firm controls the price, and it gets really difficult for small firms to sell similar services or goods to compete. There are times when dominant firms lower prices to such a level that the small firms can’t survive and exit. Then the dominant firm increases the prices at its free will. It is illegal. The government should always check whether the dominant firm is killing competition.

• Indian Telecom Company (Reliance JIO) gave a free Internet and calling facility more than six months after its launch. The existing telecom providers were charging for both Internet and calling.
• Previously customers used to limit internet usage to 2GB per month. After the launch of JIO, they started using unlimited data daily. It was a revolution. The calling was made entirely free.
• It led to a huge change in the telecom industry of INDIA. Several small providers started Merging to survive or exit from the market.
• Slowly, when JIO started charging cheap rates from customers every month, other providers had to follow the pricing mechanism of JIO to survive. It is an example of price leadership.

• The market should be an oligopoly. That is, there should be very few firms in the market. One firm among them should be big enough to control the price.
• The products should be homogeneous. It means that different firms will produce similar goods or services. So the customers will not have a preference and will go towards the less costly.
• The cost of production for a particular firm should be less to dominate the price.

• It reduces price wars. In price leadership, small firms follow the price of the dominant firms, so they are not engaged in a price war to gain market share, which reduces the profitability for all firms.
• If a market leader increases the price and another small firm follows it, it will increase the probability for all the small firms and the big firm. So small firms are enjoying the price set by the leaders.
• When the dominant firm decreases the price and other firms follow, buyers gain from the low prices. It helps to increase savings as money is saved.

• Most smaller firms can’t survive with the defined price by the leaders. It reduces competition, and chances of monopoly arise.
• If the price is increased and other firms follow, then buyers lose. So it isn't nice for the consumers.
• As the profitability of the smaller firms decreases, the employees' salary is affected, and the future sustainability of the firm is in question, which will lead to more unemployment in the economy.

Price Leadership is often followed when a strong firm tries to show its presence in the market. Following price leadership and not engaging in a price war is beneficial for small firms. There should be regulations to control price leadership if the motive behind the price leadership is a monopoly or to charge higher prices from buyers.

This has been a guide to what is Price Leadership & its Definition. Here we discuss the types of price leadership and their advantages and disadvantages. You can learn more economics from the following articles –

• Market Price
• Voodoo Economics
• Microeconomics Formula
• Equity in Economics