To maintain price leadership, a dominant firm must ensure that _____ .
the small firms do not produce more or less than the level agreed upon market sharing agreement
the small firms do not produce more or less than the level agreed upon market sharing agreement option is correct.
Price leadership by a dominant firm works only when the fringe of small firms behaves predictably. In the market-sharing variant of the dominant-firm model, the leader announces a price and each follower agrees to supply a fixed share of the market. If a fringe firm produces above its quota it undercuts the leader’s price and destabilises the arrangement; if it produces below quota it forces the leader to absorb the residual and depresses the leader’s residual demand.
Thus the leader’s ability to hold price above the competitive level rests on the small firms respecting the agreed output shares. This is the standard condition emphasised in the Baumol / Koutsoyiannis treatment of price leadership.
Charging a price below the market price would be a self-imposed constraint unrelated to the followers’ behaviour, and preventing quality upgrades or innovation is a non-price concern that does not underpin the leader’s pricing rule itself.
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