Price Leadership: A Theoretical Analysis

Abstract

This paper establishes a price leadership model which deals with various types of price leadership in a consistent manner, and reclassifies price leadership into three types from a theoretical point of view. Many economists, such as Forchheimer (1908), Nichol (1930), Stigler (1947b), Markham (1951), Lanzillotti (1957) and Bain (1960), have described various types of price leadership. These have been classified by Scherer (1970) into three types: dominant, collusive, and barometric price leadership. The dominant type' is considered to describe industries in which a dominant firm, which has the largest market share, solidly establishes the price leadership position with the other minor firms being followers. The collusive type (the monopolistic type of Stigler's barometric price leadership) is where some principal firms set prices which are followed by other minor firms, and so the price level is rather monopolistic than competitive. Scherer (1970, p. 170) has stated that price-leaders temper their price policies in order to suppress intra-industry conflicts in this case.2 Finally, in the barometric type (the competitive type of Stigler's barometric price leadership), the price is set around the competitive level.3 Bain (1960, p. 201) has characterized this type as the leadership-plus-price-concession pattern. However, their classification is based upon either market structure or conduct, and they have neither explained why the market structure is thus decided nor clarified why each firm chooses the present behaviour pattern, since they have not established a general price leadership model which can consistently deal with various types of price leadership. Therefore, the criteria for the traditional classification are rather ambiguous from a theoretical point of view. For example, though the dominant type is distinguished as that with the largest market share, the value of the critical share for a dominant firm to emerge is vaguely decided.4 One of the criteria that discriminates between collusive and barometric price leadership is whether the equilibrium price is monopolistic or competitive, but how can we determine the value of the critical price? In order to eliminate the ambiguity and deduce several types of price leadership theoretically from such fundamental conditions as the market demand, differences in marginal cost and in quality of products, we analyse here the relation between those conditions and each firm's optimal behaviour pattern. On the basis of this analysis, an investigation of the consequences of each firm's behaviour pattern leads us to adduce some theoretical basis for the various types of price leadership. The present paper describes, in Section I, a price leadership model in the case of homogeneous and heterogeneous goods, and develops several theorems that clarify why and when each firm prefers either the price leadership position or the followership position. Using these theorems, Section II reclassifies the price leadership theoretically into three types. Section III summarizes and concludes this paper.

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