Price Leadership

Published Oct 25, 2023

Definition of Price Leadership

Price leadership is a situation in the market where one firm, typically the dominant firm, sets the price for a certain product or service, and other firms in the industry follow suit. This practice occurs in industries where firms have a high degree of interdependence and limited pricing power. Price leadership can be classified into two types: dominant firm price leadership and barometric firm price leadership.

Example

To illustrate dominant firm price leadership, let’s consider the mobile phone industry. Imagine that Apple, as the dominant firm in the market, introduces a new flagship phone at a certain price. Other mobile phone companies, such as Samsung and Google, closely monitor Apple’s pricing decisions. If Apple increases the price of its flagship phone, the other companies may follow suit by raising their prices as well. Conversely, if Apple reduces the price, the other companies may also lower their prices.

Barometric firm price leadership, on the other hand, occurs when multiple firms in an industry take turns leading price adjustments based on market conditions. For example, suppose there are three major airlines: Delta, United, and American Airlines. If Delta increases its ticket prices due to rising fuel costs, the other two airlines may follow suit. However, if market conditions change, and United is the first to lower its prices to attract more customers, the other airlines may then adjust their prices accordingly.

Why Price Leadership Matters

Price leadership is an important phenomenon in markets where competition is limited and firms have a significant influence over pricing decisions. It helps maintain stability and avoid price wars that can harm the profitability of all firms in the industry. Price leadership can also provide insights into market trends and help firms anticipate and respond to changes in customer demand and market conditions, ensuring sustainable growth and profitability.