Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

Figure 2.2 
The dominant firm will sell A
1
B
1
at this price. In order to 
locate the demand curve for the dominant firm, we relate price 
(OP
1
) and demand for the dominant firm's product at this price. 
For this purpose, we take a distance equal to P
1
C
1
which is the 
same thing as A
1
B
1
. In other words, we transfer distance A
1
B
1
to 
the left so that it gets coordinated with the price OP
1
. It is thus 
clear that at the price OP
1
, the dominant firm will sell P
1
C
1
. C
1
is a 
point which would lie on the dominant firm's demand curve. In the 
same manner, we can consider other prices and link the demand 
for the dominant firm's product with these prices. In this manner, 
we obtain the dominant firm's demand curve. It is shown as P
1
d in 
the diagram. Having located the demand curve, we can locate the 
MR curve of the dominant firm which lies below the AR curve. In 
the diagram, MR
d
shows the MR of the dominant firm. MC
d
is the 
marginal cost of the dominant firm. 

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The dominant firm is to set the price. It will follow the 
general principle of profit maximisation i.e. MC = MR. The 
dominant firm maximises its profits at output level OQ because it 
is at this output that MC
d
is equal MR
d
. Thus, dominant firm sets 
the price OP
2
. At OP
2
price, the total market demand is OQ of 
which the dominant firm supplies OQ
d
and the rest O
d
Q is 
supplied by the small firms. It may be noted that the dominant firm 
maximises its profit by equating its marginal cost to its marginal 
revenue. The smaller firms being price-takers, may or may not 
maximise their profit. It all depends on their cost structure. But one 
thing is definite. It the dominant firm wishes to maximise its profits, 
it must make sure that the small firms will not only follow its price, 
but will also produce the right amount of output. Unless there is a 
tight market sharing agreement the small firms may produce less 
than OQ
s
and thus force the dominant firm to a position where 
profits are not the maximum. 
There can be many variations of the dominant firm model. 
For instances if there are two or more dominant firms in an 
industry, the small firms may look to one or all of the large firms 
for price leadership. Product differentiation may further complicate 
the situation.