In economics, a kinked demand curve is a graphical representation of how a firm's price and quantity demanded may change in response to a price change by a rival firm in an oligopoly market structure. An oligopoly is a market structure in which there are a few firms that dominate the industry and are able to influence prices.
The kinked demand curve model was developed to explain the behavior of firms in oligopoly markets. According to this model, firms in an oligopoly market face a dilemma when deciding whether to raise or lower their prices. If one firm raises its price, it may lose market share to its rivals. On the other hand, if it lowers its price, its rivals may also lower their prices, leading to a price war that would ultimately drive down profits for all firms in the industry.
The kinked demand curve represents this dilemma by showing two different slopes for the demand curve. The first slope represents the downward sloping portion of the demand curve, which shows the negative relationship between price and quantity demanded. The second slope represents the flatter portion of the demand curve, which shows the less sensitive relationship between price and quantity demanded.
The kink in the demand curve occurs at the current market price, and it represents the point at which the firm must decide whether to raise or lower its price. If the firm raises its price above the current market price, it will lose market share to its rivals, as shown by the steep downward slope of the demand curve. If the firm lowers its price below the current market price, its rivals may also lower their prices, leading to a price war and a decrease in profits for all firms in the industry, as shown by the flatter portion of the demand curve.
The kinked demand curve model helps to explain why firms in oligopoly markets may be hesitant to change their prices and why they may choose to maintain a certain level of price rigidity. It also helps to explain why oligopoly markets may be characterized by price stability and non-price competition, such as advertising and product differentiation.
Overall, the kinked demand curve is a useful tool for understanding the behavior of firms in oligopoly markets and the impact of price changes on their profits and market share.
Why is the kinked demand curve kinked?
What is the nature of demand curve? These happy competitors will have therefore no motivation to match the price rise. Those firms will face different effects for both increasing price or decreasing price. E none of the above. Under these circumstances the firm will increase its price with the certainty that the others in the industry will follow, since their costs are similarly affected. In an oligopolistic market, the kinked demand curve hypothesis illustrates that the firm faces a demand curve with a kink at the level of prevailing price.
Kinked Demand Curve Model of Oligopoly (With Diagram)
F irms will try to spread awareness of the company and their products through branding and advertising in an attempt to make consumers purchase regularly. They collude and agree to share the market equally. How does a company become a low-cost price leader? We see price rigidity. The net effect is that if all firms cut price — the individual firm will only see a small increase in demand. B then rival firm Y will increase its market share if firm Y also increases its price. This causes the demand for goods produced by the firm attempting the price increase to fall.
The basic assumption underlying the kinked demand curve is that rivals will not follow an attempted increase in price by one of the firms but will follow a decrease. ADVERTISEMENTS: Second, in the model under discussion, the prices of the products are given initially, and a relation between these prices has been established already. This will result in a price war. When an oligopoly increases the price above the equilibrium level, the competitors maintain their prices. The assumptions of this model are: ADVERTISEMENTS: i There are only a few firms in an oligopolistic market. This result means that the price it receives is the same for every unit sold. Movement along a demand curve takes place when the changes in quantity demanded are associated with the changes in the price of the commodity.
A A natural or legal barrier to entry exists. What kind of game is it when firms choose their optimal pricing strategy today without worrying about possible interactions in the future?. Answer: In an oligopolistic market, the kinked demand curve hypothesis states that the firm faces a demand curve with a kink at the prevailing price level. If the price is cut, it may encourage first-time users to try. A "Gas prices in this town always go up and down together. What are the negative effects if large oligopolists do not advertise? Other firms will follow this behaviour and also cut their prices, resulting in a price war. The theory, however, does not consider this possibility.
The kinked-demand hypothesis does not explain the height of the kink. As explained by the kinked demand model, any increase in price is bound to result in drop in market share of the firm and any decrease in price is not going to result in any gain in market share. If an oligopolist lowers the price below the equilibrium level, the competitors lower their prices too. C average variable cost curve is discontinuous. B other firms will lower theirs. What is the difference between movement and shift in demand curve? You just studied 45 terms! The business would then lose market share and expect to see a fall in its total revenue.
There is nothing in the kinked demand theory which explains how the price which is prevailing is determined. ADVERTISEMENTS: It is for explaining price and output under oligopoly with product differentiation, that economists often use the kinked demand curve hypothesis. Assumptions of the Kinked Demand Curve Model 2. Likewise, the kinked demand curve theory explains that even when the demand conditions change, the price may remain stable. Due to the kink in the demand curve of the oligopolist, his MR curve is discontinuous at the level of output corresponding to the kink.
Last Update: October 15, 2022 This is a question our experts keep getting from time to time. Also, we have provided the lots of designing services like logo design, poster design, thumbnail design, and content writing servies. As there is high degree of interdependence between the firms, the firms demand curve is indeterminate under oligopoly. There is a lot of non-price competition. Further, under oligopoly without product differentiation, there is a greater tendency on the part of the firms to join together and form a collusion, formal or tacit, and, alternatively, to accept one of them as their leader in setting their price.
The marginal revenue curve will look like the diagram below. B potential entrants entering and incurring economic loss. B assumes marginal cost is constant. How does the kinked demand curve explain price rigidity in oligopoly? Consumers benefit from cheaper prices, but supermarkets will experience less total revenue and profits. The kinked-demand curve model also called Sweezy model posits that price rigidity exists in an oligopoly because an oligopolistic firm faces a kinked demand curve, a demand curve in which the segment above the market price is relatively more elastic than the segment below it.