A kinked demand curve is a type of demand curve that is often used to describe price behavior in monopolistically competitive markets. Monopolistically competitive markets are markets where there are many firms selling products that are similar, but not exactly the same. This type of market structure is often referred to as "imperfect competition."
The kinked demand curve model was developed by economist Paul Sweezy in the 1940s as a way to explain why firms in monopolistically competitive markets tend to have a harder time raising prices than firms in more competitive markets. According to the model, firms in monopolistically competitive markets are hesitant to raise prices because they are afraid of losing market share to their competitors. On the other hand, firms are also hesitant to lower prices because they are afraid that their competitors will follow suit and engage in a price war.
The kinked demand curve model is often depicted as a standard downward-sloping demand curve with a "kink" in it. The kink represents the point at which firms become hesitant to raise or lower prices. To the left of the kink, the demand curve is relatively inelastic, meaning that changes in price have a small effect on the quantity of goods demanded. To the right of the kink, the demand curve is relatively elastic, meaning that changes in price have a larger effect on the quantity of goods demanded.
One of the key assumptions of the kinked demand curve model is that firms in monopolistically competitive markets are interdependent. This means that the actions of one firm will affect the actions of its competitors, and vice versa. For example, if one firm raises its prices, it may lose market share to its competitors. However, if all of the firms in the market raise their prices at the same time, they may be able to maintain their market share and increase their profits.
Overall, the kinked demand curve model is a useful tool for understanding the behavior of firms in monopolistically competitive markets. It helps to explain why firms in these markets are often hesitant to raise or lower prices, and why they may be more stable than firms in more competitive markets.
How To Draw The Kinked Demand Curve.
However, it does not explain the level of the price at which the kink will occur. Why is there a discontinuity in the kinked demand curve? Hence, cocaine has a kinked demand curve as the kink lies in between the inelastic and elastic demand curves. Mobile phone companies can increase the price but consumers are willing to pay because the price is not the dominant factor. Because the marginal cost curve intersects the marginal revenue curve before it intersects the average total cost curve, oligopolies never reach an efficient scale of production efficiency, since they never operate at their minimum average total cost. In other words, the demand curve is a series of intersections, showing exactly how many products consumers will demand at a particular price point. The reason why there is a kink in the demand curve is that there are two demand curves: one that is inelastic and one that is elastic.
The kinked Demand Curve: Meaning, Examples & Characteristics
How does the kinked demand curve explain price rigidity in oligopoly What are the shortcomings of the kinked demand model? The MC curve intersects the MR curve in that vertical section. Movement in demand curve, occurs along the curve, whereas, the shift in demand curve changes its position due to the change in the original demand relationship. The ceteris paribus assumption: Supply curves relate prices and quantities supplied assuming no other factors change. This model of oligopoly suggests that prices are rigid and that firms will face different effects for both increasing price or decreasing price. Economists racked up their brains all day but could not explain this strange phenomenon.
However, this only happens when there is an increase in demand, i. The following figure plots the kinked demand curve diagram. ADVERTISEMENTS: Fourth, in the model under discussion, the firm may not have to change the price of its product, even if its cost of production rises. Why the Kink in the Demand Curve? There is only one case in which a rise in cost will most certainly induce the firm to increase its price when costs rise, despite the fact that the higher costs pass through the discontinuity of the MR curve. What is Indeterminateness of demand curve? Tesco spent £1 billion on store revamps and price cuts in 2014 to fight back against the discounts offered in Lidl and Aldi. As can be seen above, a firm cannot gain or lose by changing its price from the prevailing price in the market. Bhaskar "The Kinked Demand Curve: A Game-Theoretic Approach," International Journal of Industrial Organization 6, 1998 : 373.
The possibility of collusive behaviour is illustrated in the alternative theory called the cartel theory of oligopoly. This will occur when firms will concentrate on non-price competition to strengthen their market position and raise their supernormal profits. It would be able to maximise profit if it, like the previous case, sells of output at the price of p 1. The assumptions made are also its main drawbacks. What are the positive effects of large oligopolists advertising? Hitch on the other hand. In addition, the elephant in the room is the fact that the Kinked Demand Curve takes the current price and quantity to be a given, as a starting point for the construction of the model.
Monetarist, Keynesian, and New Classical Economics. The MR has two segments segment dA corresponds to the upper part of the demand curve, while the segment from point B corresponds to the lower part of the kinked-demand curve. The kinked demand curve can explain the behaviour of firms within an oligopoly market structure to some extent. Firms don't want to cut prices because they will start a price war, where they don't gain market share, but do get lower prices and lower revenue. The kinked demand curve model seeks to explain the reason of price rigidity under oligopolistic market situations. Why is there a discontinuity in the kinked demand curve? That is because when an oligopolist cuts prices on its products, its competitors may think that they are not following the model, resulting in losing customers. Why the price rigidity? Thus the kink can explain why price and output will not change despite changes in costs within the range AB defined by the discontinuity of the MR curve.
The kinked demand curve examples There are many examples that show the kinked demand curve in practice. Analysis of the Kinked Demand Curve Model. Later, the birth of the cartel theory covered many of its drawbacks. Additionally, what is the basis of a kinked demand curve model? Point c gives the equilibrium price and quantity. Intersection of the MC with the MR segments requires abnormally high or abnormally low costs, which are rather rare in practice. It is, however, not a legitimate explanation, either. Thus total profit is maximised at the point of the kink.
Kinked Demand Curve Model of Oligopoly (With Diagram)
Drawbacks Of Kinked Demand Curves First, it does not explain the mechanism of establishing the kink in the demand curve. One of the primary reasons is that it does not describe how the oligopolist finds the kinked point in its market demand curve. 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. But there is a good chance that the price of the product of a firm would be consistent with its goal of profit maximisation. This important element is outside the scope of the model. The kink in the demand curve occurs because rival firms will behave differently to price cuts and price increases. In the first place, as the demand curve or the average revenue AR curve of the firm has a kink, its MR curve cannot be obtained as a continuous curve.
Kinked Demand Curve: Concept, Graphical Representation, Examples etc.
We may, therefore, begin with the properties of the MR curve of the kinked demand curve with the help of Fig. The reason is quite simple: the price increase could result in a drastic sales decrease. In both cases, there is no increase in demand for the firm which changes its price. Why are prices rigid or sticky in oligopoly? Economists, thus, have developed many price-output models to explain the oligopoly market behaviour. But, it does not explain how the existing price OP 1 is arrived at. If the cost of production rises along with a shift in the demand curve, then also, profit maximisation may not require the firm to change the price of its product.