Kinked Demand Curve2

Kinked demand curve
The kinked demand curve of oligopoly was developed by Paul M. Sweezy in 1939.
One of the important features of Oligopoly market is price rigidity.
Change in price would not be profitable for an organization in oligopoly. In case, an organization reduces
its price, its rivals also reduce prices, which adversely affect the profits of the organization. In case, the
organization increases prices, it would lose buyers.
To explain the price rigidity under Oligopoly market, conventional demand curve cannot be used.
So Paul Sweezy in 1939 came with an idea of non-conventional demand curve to represent non-collusive
oligopoly. Sweezy uses a Kinked demand curve to describe price rigidity in Oligopoly market.
Assumptions
1. There are only a few firms in an oligopolistic market.

2. The firms are producing close-substitute products.
3. The quality of the products remains constant and the firms do not spend on advertising.
4. A set of prices of the product has already been determined and these prices prevail in the market
at present.
5. If one oligopolistic organization reduces the prices, then other organizations would also cut their
prices.
6. If one oligopolistic organization increases the prices, then other organizations would not follow
increase in prices.
There is an asymmetric behavior among oligopoly sellers.

When 1 firm reduces the price all other will follow him and the firm which reduce the price will not get
much additional customers, hence demand is less responsive to a reduction in price. Thus, the demand
curve is steeper in the lower portion.
On the other hand, when the firm increases the price others will never follow him and the firm which
increased the price will lose many of its customers. Thus, demand is more responsive to a price increase.
Demand curve is flatter in the upper portion
As a result of this behavioral pattern, demand curve will be kinked at the ruling market price.
The kinked demand theory is explained with the help of the following figure:
From the figure, Prevailing price of an Oligopoly product in the market is OP1.
If 1 seller increases the price above OP1, rival sellers will keep their price at OP1. As a result of high price
charged by the firm their customers will shift to others. Consequently, sales of 1st seller will drop.
This shows high response (in demand) towards a price hike and there by the upper portion of the
demand curve is more flatter (shows high price elasticity of demand).
If 1 seller reduces the price below OP1, rival sellers will follow him. So that no one will lose their
customers.
This shows less response (in demand) towards a price reduction and there by the lower portion of the
demand curve is more steeper (shows less price elasticity of demand)
This behavioral pattern explains why prices are inflexible in the oligopoly market.
The MR curve would take the discontinuous shape.

MR curve has 2 segments. A discontinuity in the MR curve occurs between A and B. MR curve is vertical
in between points A and B.
Equilibrium is achieved when MC curve passes through the discontinuous portion of the MR curve.
(where MC=MR). At this point organization would achieve maximum profit.
Equilibrium Output = OQ1
Equilibrium Price=OP1
Suppose cost rises, MC curve will shift up from MC2 to MC1 when cost lowers, MC curve will shift down
from MC2 to MC3.
The firm will produce output OQ1 at OP1 price, if the MC curve shift up or down on the vertical part of
MR curve, the firm will not change its price and output.
This facts explains oligopolistic price is more stable than cost.
Limitations
At first sight, the model seems to be attractive since it explains the behaviour of firms realistically. But
the model has certain limitations:
1. It does not explain how the ruling price is determined. It explains that the demand curve has a kink at
the ruling price.
2. Price rigidity conclusion is not always true. Rival organizations only follow price decrease, which does
not hold true empirically.
3. Ignores non-price competition among organizations. Non-price competition can be in terms of
product differentiation, advertising, and other tools used by organizations to promote their sales.

Kinked Demand Curve2

Uploaded by

Copyright:

Available Formats

Kinked Demand Curve2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Kinked Demand Curve2

Uploaded by

Copyright:

Available Formats

Kinked demand curve

1. There are only a few firms in an oligopolistic market.

There is an asymmetric behavior among oligopoly sellers.

The MR curve would take the discontinuous shape.

You might also like