ECON 575

Dominant Firm Model

Semester 222
 Outline
• Characteristics of Dominant firm and Fringe
firm
• Market equilibrium determination

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 Introduction
• Dominant firm is closely related with
monopoly market (because of the existence of
market power)
– Some firms are dominant because they are low
cost producers and thus, have control over the
market price
– Fringe firms only enters when the price is high
enough to cover their marginal costs (production
cost)

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 Dominant Firm
• Dominant firm:
– The more quantity supplied to the market, the lower the
market price due to the negative slope of the demand curve
– The less quantity supplied to the market, the higher the
prices and thus, fringe firms are more likely to enter
– Controls the fate of the fringe firm

• There exist a quantity, in which at that exact quantity,

the whole market would belong to dominant firm
(critical quantity)

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 Fringe Firm
• Fringe firms:
– price-takers, their decision is based on what the market
price is
– No market power
– It’s existence depends on the “strategy” of the
dominant firm and its own marginal cost

• There exist a price, in which at that exact price

level, the fringe firm would not exist (critical price)

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 Determining Equilibrium
• Dominant firm should decide based on
maximizing profit, not maximizing market share
– Maximizing market share does not necessarily
equal to maximizing profit
• Decide based on MR = MC
– Remember, MR is derived from Total Revenue that
comes from the demand
– There are 2 distinct demand, the demand when
fringe firms are operating and not operating

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 Market Equilibrium
• There are 3 distinct cases:
1. MC of dominant firm intersect the MR of the
market demand
• Fringe firm is not operating, price is lower than critical
price
2. MC of dominant firm intersect the MR of the
dominant firm demand
• Fringe firm is operating, price is higher than critical price
3. MC crosses the critical quantity
• Fringe firm is not operating, price is exactly at critical price

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 Case 1
P

MCf
Ddom
Pc
P*

MCdom

M Dmarket
RD,res
Qc
Q
Q*
MRD,market
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 Case 2
P

MCf
Ddom
MCdom
P*
P
c

Dmarket
MRD,res
Qdom*
Qf * Q
Q
Q*c
MRD,market 9
 Case 3
P

MCf
Ddom
Pc
P*

MCdom

D
MRD,res market

Qc
Q
Q*
MRD,market 10
 Dominant Firm (2)
• In reality, especially in energy, the dominant
firm consists of a few different firms
– There are many low cost producers
– The low cost is due to the characteristics of the
energy source
• It is also interesting to look at the firms
behavior that makes up the dominant firm
– Related to the multiplant monopoly model where
there is an incentive to cheat
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 Conclusion
• Dominant firm model proves that maximizing
market share does not necessarily mean
maximizing profit
• If the dominant firm consists of many firms, it
is bound to fail because of the incentive to
cheat (similar to the case of multiplant
monopoly)
– Due to uncertainty of profit sharing

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