Dominant Firm Model

1. Dominant Firm Model
The dominant firm model describes markets in which there is one large firm and many
small firms. The small firms are price-takers and are called the competitive fringe.
The large firm accounts for the majority of industry output and sets price taking into
account the supply curve of the fringe.
Assume that market demand is given by
Q = D(P) = 200 – P.
There are n =10 fringe firms, each with costs
TC = 5q2
+ 40q, MC = 40 + 10q
The supply curve of the competitive fringe is therefore
QCF = S(P) = P – 40.
Costs for the dominant firm are
TC* = 40Q* + 1000, MC* = 40
• Derive the demand curve for the dominant firm
Q* = D*(P) [D(P) - S(P)] = 240 -2P, P 120
Marginal revenue is given by
MR* = 120 – Q*
The dominant firm maximizes profits by equating MR to MC.
120 – Q* = 40,
Q* = 80, P = 80, 2200=
• Compute the output of the fringe and verify that the market clears.
QCF = S(80) = 40, Q* = 80, Q = QCF + Q* =120 = D(80)

2. Each fringe firm produces q = 4 units of output and makes a profit .160$=
Exercise
1. The imposition of an excise tax on the dominant firm
a. raises market price..
b. increases fringe firm output.
c. increases fringe profits.
d. reduces dominant firm output by more than the increase in fringe output.
e. all of the above are correct.
2. One of the following is incorrect. The imposition of an excise tax on fringe firms
a. reduces fringe firm profits.
b. shifts the demand and marginal revenue curves of the dominant firm rightward.
c. increases dominant firm profits.
d. increases dominant firm output.
e. raises market price.
P
200
D
MR*
MC*
80
S
D*
40
0 40 80 120 200 Qty