The kinked demand curve model describes an oligopoly market with few firms producing close
substitute products. The demand curve these firms face is not smooth, but has a kink at the prevailing
price level. Above this price, the demand curve is elastic as competitors will not follow a price increase;
below it is inelastic as competitors will follow a price decrease. This difference in elasticity creates a
discontinuity in the firms' marginal revenue curves at the kink. Equilibrium occurs where marginal cost
equals marginal revenue at this kinked price level, leading to price rigidity in the market.
The kinked demand curve model describes an oligopoly market with few firms producing close
substitute products. The demand curve these firms face is not smooth, but has a kink at the prevailing
price level. Above this price, the demand curve is elastic as competitors will not follow a price increase;
below it is inelastic as competitors will follow a price decrease. This difference in elasticity creates a
discontinuity in the firms' marginal revenue curves at the kink. Equilibrium occurs where marginal cost
equals marginal revenue at this kinked price level, leading to price rigidity in the market.
The kinked demand curve model describes an oligopoly market with few firms producing close
substitute products. The demand curve these firms face is not smooth, but has a kink at the prevailing
price level. Above this price, the demand curve is elastic as competitors will not follow a price increase;
below it is inelastic as competitors will follow a price decrease. This difference in elasticity creates a
discontinuity in the firms' marginal revenue curves at the kink. Equilibrium occurs where marginal cost
equals marginal revenue at this kinked price level, leading to price rigidity in the market.
The kinked demand curve model describes an oligopoly market with few firms producing close
substitute products. The demand curve these firms face is not smooth, but has a kink at the prevailing
price level. Above this price, the demand curve is elastic as competitors will not follow a price increase;
below it is inelastic as competitors will follow a price decrease. This difference in elasticity creates a
discontinuity in the firms' marginal revenue curves at the kink. Equilibrium occurs where marginal cost
equals marginal revenue at this kinked price level, leading to price rigidity in the market.
The kinked demand curve is one of the important features of an oligopoly market. An oligopoly market is a form of an imperfect market. There are few firms in the market, but each firm is large and has a relatively large share of the total market supply. The firms either sell identical products or sell differentiated products.
There are significant barriers to the entry of new firm and that barrier imposed by the need for a larger amount of fixed investment. Example – If any businessman seeks to enter the telecommunication market in India, it requires a huge investment.
Also there is huge interdependence among the firms. One firm’s decision affects all firms, so all firms follow the other firm. This is called the group behaviour
Also, firms spend huge amounts of money on advertising in order to attract the consumer and increase their share in the market. Often, price rigidity exists because of group behaviour.
The Kinked Demand Curve Model
This model was developed independently by Prof. Paul M. Sweezy on the one hand and Profs. R. C. Hall and C. J. Hitch on the other hand. Mostly the model developed by Prof. Paul M. Sweezy is mostly accepted. This model is more appropriate in case of differentiated oligopoly when the products are close substitutes.
Assumptions of the Model
1. There are few firms in the market.
2. They do not spend much on advertising. 3. Firms have perfect information about the demand curve. 4. They are producing close substitutes 5. Firms are aware of their interdependence
The Demand Curve
Here the demand curve is not smooth and it has a kink at the prevailing level of price. The shape of the demand curve is given in the figure.
In above figure the demand curve is dD and it has a kink at the prevailing price OP. The upper portion i.e. dP is elastic and the lower portion DP is inelastic. The elasticity difference between two portions emerges because of differential reaction of the firms following a price rise or fall. Difference in Elasticity The upper portion is elastic because if any one firm increases the price above the prevailing one, no other firm will follow him. So his product will become relatively dearer and he would lose a larger amount of his sale. The lower portion is inelastic because if any one firm reduces the price below the prevailing one, all other firm will follow him. So his product will not become relatively cheaper and his gain will be very less.
Marginal Revenue Curve
The green line in the above figure represents the marginal revenue curve. The MR curve here has a discontinuous portion at the point of the kink in the AR or demand curve. The length of this discontinuous portion depends on the elasticity difference between the lower and upper portions of the demand curve. The higher the difference in elasticities, the higher will be the length of the discontinuous portion in the MR curve and vice versa.
Equilibrium The equilibrium is achieved when the marginal cost is equal to the marginal revenue. Below figure the equality of both determines P1 price and Q1 quantity. This price remains sticky given the explanation before.
