Figure 2.

2.2.2. Leadership by the dominant firm:

In oligopoly market, large and small firms exist side by

side. When the oligopoly is composed of a large firm and many
small firms, the large firm becomes the dominant firm and acts as
the price-leader. The dominant firm sets the price for the industry
and allows the small firms to sell all that they want to sell at that
price. The rest of the market demand for the product is met by the
dominant firm. For the small firms, the price is given and fixed and
they can behave as if it were perfect competition for them. It is
clear that each small firm is faced with a perfectly elastic demand
curve (horizontal straight line). This demand curve is situated at
the level of the price fixed by the dominant firm. It means that
each firm behaves as if it were functioning in atmosphere of
perfect competition. The only difference is that in a competitive
market, the industry sets the price, but in this case, the price is
fixed by the dominant firm. Since for every small firm, the demand
curve is horizontal straight line, its marginal revenue curve
coincides with it. In other words, for a small firm, AR = MR. The
small firm's AR curve (demand curve) is also its MR curve. Thus,
in order to earn maximum profits, the small firm should produce
that output at which its marginal cost is equal to its marginal
revenue i.e. the price fixed by the dominant firm. By horizontal
summation of the marginal cost curves of the small firms, we
obtain the supply curve for all the small firms. In Fig. 2.2, CMC is
such a supply curve for the small firms. This supply curve shows
the amounts of the product which all the small firms taken together
will place in the market at different prices. DD indicates the market
demand curve. It shows what amounts of the product the