Assumptions:
DOMINANT FIRM AND "FRINGE" FIRMS
- There is a "dominant" firm, producing a commodity, whose dominance rests on its lower cost structure (and it has little or no difficulty managing at a large scale).
- There is a "fringe" of other firms that produce the same commodity and that have higher costs and have difficulties expanding their outputs (e.g., because they have greater difficulties in managing at large scale); but they are persistent and cannot be permanently scared away by temporarily low prices.
- The fringe firms do not act strategically but just react to any price that prevails and produce accordingly; this is the supply curve of the fringe firms.
- The dominant firm knows the supply curve of the fringe and does act strategically by "backing out" the fringe's supply (at any price) to determine the "residual" demand (and residual marginal revenue) that is realistically available to it.
$ Supply by the fringe firms
Overall market demand
Residual demand available
to the dominant firm
P Marginal revenue derived
from the residual
demand
Marginal cost of the
dominant firm
0 Q fr
Q dom
Q total
Note: An equivalent result can be reached by assuming that the market is one of differentiated products and that the dominant firm's advantage rests on its superior brand reputation, while the fringe firm's limited capability of expanding their sales is due to their weaker brand images. Again, the dominant firm will want to act strategically and "back out" the consequences of the fringe's actions in considering its own best price-quantity choice.