Price Leader

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Definition: Price Leader

Sometimes, in an industry, small firms follow the prices set by a powerful firm from the same industry. This powerful firm is known as price leader and is usually the industry leader. The rivals have little choice but to follow the price leader, if they want to hold on to their respective market shares. Also, sometimes rivals may reduce their prices as compared to the price leader just to grab a bigger chunk of the market.

Commonly, price leader use their operating efficiencies to mark down prices. This puts pressure on the smaller firms to reduce their prices as well, in order to maintain their market share. In absence of economies of scale, as compared to price leader, such small firms suffer prolonged losses. Some of them may be forces to leave the industry.

Price leadership is common in oligopolies, where major policy decisions taken by the price leaders immediately affect the competitors, who react with their own counter-strategies.

Price leader can be of 3 types:

• Dominant Firm: The large firm in any industry act as price leader having a high market share of the product. They fix the prices and other firms accept such set-prices.

• Collusive: An explicit or a tacit collusion in an oligopoly can give rise to price leaders in the industry. This group of market leaders become the price leaders and set the prices of the products, which are then followed by smaller firms.

• Barometric: A small but efficient producer, having a small market share in an industry, can act as the barometer and reflect changing market conditions, along with the changing costs of production. This way they induce the rice changes necessary to survive in the industry. Such leaders are short lived.

The advantages of price leadership are:

• There is no uncertainty regarding price decisions in markets like oligopoly.

• This process of price leadership leads to development of new and better quality products.

• Reduction in the possibility of a price-war.

• Mutual understanding among firms can lead to better growth of the economy.

Hence, this concludes the definition of Price Leader along with its overview.

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