Dominant Firm

  • A dominant firm model is a blend of our baseline models of perfect competition and monopoly
    • The dominant firm model gives us a more realistic representation of markets
  • The dominant firm has power to set a price that maximizes its own profits.
    • The market contains many firms but most of them are very small and act as perfect competitors (i.e. price-takers)
    • This group of firms is referred to as the competitive fringe
    • The dominant firm must take into account the competitive fringe, in addition to demand, when making its price and output decision

Model Assumptions

  • The dominant firm has lower production costs than the other firms in the competitive fringe
  • The dominant firm knows the market demand and how much output the competitive fringe will produce
  • All firms in the competitive fringe are price-takers
  • All firms produce homogeneous products


  • Lower profits for dominant firm
  • Lower price paid by consumers

Examples of markets where a dominant firm (fringe) model is appropriate

  1. AT&T (1982): controlled the telecommunication industry through government regulations, vertical integration, and competitive practices.
  2. Microsoft (2002): tied its Internet Explorer browser with Windows and restricted the market for competing browsers
  3. OPEC: a cartel that operates as a dominant firm
  4. Hotels and Airbnbs: hotels set prices and Airbnb hosts act as price-takers (maybe not so much anymore… )

Solving the dominant firm model

  • Let \(S_{cf}\) be the fringe supply curve and \(D\) be market demand
    • The dominant firm must account for the competitive fringe and calculates the residual demand curve: \(d=D-S_{cf}\)
    • Once the dominant firm accounts for the presence of fringe firms, the dominant firm acts as a monopolist
  • Dominant firm (subscripted as \(df\)) has lower costs and sets the price
  • The competitive fringe (subscripted as \(cf\)) is comprised of price-takers
  • Dominant firm sets price off of residual demand after choosing the profit maximizing quantity (\(MC = MR\))
  • Competitive fringe dampens the pricing power of the dominant firm
    • Note difference between residual demand price (\(d\)) and market demand price (\(D\)) at \(q_{df}\)
  • Note that \(q_{total}=q_{cf}+q_{df}\)

Suppose we’re looking at a market with a dominant firm where the marginal cost, market demand, and competitive fringe are given below:

\[ MC=28\\ D(p)=180-2p\\ S_{cf}(p)=10p-300 \]

The equilibrium for this model is comprised of an optimal quantity for the dominant firm, competitive fringe quantity, and a price set by the dominant firm

\[(q_{df}, q_{cf}, p^{\ast})\]

First, find residual demand

\[ \begin{aligned} d &=D-S_{cf}\\ &=(180-2p)-(10p-300)\\ &=480-12p \end{aligned} \]

Rearrange d to find inverse residual demand then use our trick from earlier to find MR

\[ \begin{aligned} p(q) &=40-\frac{1}{12} q \\ MR(q)&=40-\frac{1}{6} q \end{aligned} \]

Next, solve for the dominant firm’s profit maximizing quantity and use that to find equilibrium price and competitive fringe

\[ \begin{aligned} MC&=MR\\ 28&=40-\frac{1}{6}q\\ q_{df}&=72\\ p(q_{df})&=40-\frac{1}{12}72 \\ p^{\ast}&=34\\ S_{cf}(p^\ast)&=10(34)-300\\ q_{cf}&=40 \end{aligned} \]

Last, check our results to ensure we found the correct equilibrium:

\[ D(p^\ast) = 180-2(34)=112\\ q_{cf}+q_{df}=40+72=112 \]