kinked demand curve

1. KINKED DEMAND CURVE

SUBMITTED BY - DEBOJIT NATH (23)
MBA IS’ SEMESTER (SEC- A)

2. INTRODUCTION

Q The kinked demand curve was first used by
Paul.M.Sweezy to explain price rigidity.

Q The assumption behind this theory of kinked demand is that each
oligopolistic will act and react in a way that keeps condition tolerable
for all members of the industry.

Q Such a situation is most likely to occur where products are qui
similar and, therefore their prices almost same.

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3. Q If one firm is rice lower than that of its competitors, these

rs will be compelled to reduce their prices to match this firm's___

Q On the other hand if one firm decides to sell at a higher price its
competitors do not react by raising their price.

Q So, in the first situation (i.e. Price reduction) the firm does not gain, while
the latter the firm loses its customer to its rival.

rival rather than start a price war.

Q So in non-collusive oligopoly the prices is tend to b

price rigidity.

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4. The most significant aspect of the solution of an oligopoly situation
is the presence of kink in the demand curve of the firm.

Q The kink shows that price reduction by a firm is followed by its
rival(competitors).

Q Therefore firm will not move away from the kink.

5. aracteristics of an Oligopolistic Market |

there are few buyers and large number of sellers

Q Fewfirms sell branded products which are close substitutes of each other.

Q Entry barriers for the other firms are high; the barriers can be due to patents, copyrights,

government rules / regulations or ownership of scare resources.

Q Firmsare interdependent for decision making.

Q Products can be homogenous (standardized) or heterogeneous (differentiated

Q Thesellers are the price makers and not price takers, si

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6. je}

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D

In this graph dd'is the individual demand curve and the firm market- share DD’ intersecting at E.

Itisbelieved that fan oligopolistic reduces his price he expect his competitors will follow the
same, while no competitors will follow when he raise the price. The relevant demand curve of the

firm is, therefore, dED’ (with a kink ar E).

For a price reduction below P, the share of the market demand curve D'E is relevant as the

countermoves by the rival will keep the market share of the firm constant.

And, for prices increases above P, the firm goes alone and, therefore, the relevant demand curve

for the firm is its own demand curve dE

If price increases are ignored by other firms but price decreases lead to lowering of prices by
competitors the firm will face a kinked demand curve as shown to the right, with the kink at the

current market price of P*

7. Price and cost

Fig:- Changes in the cost within limits do not

affect the oligopoly price

For finding out the profit maximizing price-output
combination, MR curve corresponding to kinked

demand dD has been drawn.

MR curve associated with kinked demand curve dD is
always is discontinuous

The length of this discontinuity depends upon relative
elastics of two segments dk and kD of the demand
curve,

Between MR & dD which has a discontinuous gap HR.
When MC curve of the oligopolistic passes through
discontinuous HR through point oligopolist
maximizing its profit at prevailing OP price level.

Thus it will no encourage to price changes.

When the marginal cost curves shifts upwards from MC
to MC’ due to rise in cost the output remain unchanged
since the new MC’ also passes through HR

8. Likewise when demand condition changes the price may
remain stable

Q The demand for oligopolist from dkD to d'k'D' the
marginal cost curve MC also cuts the new MR’ curve
within the gap

U Thus same price OP continues to prevail(Mk= Mk) in
the oligopolistic firm

“won

9. Criticism /drawback...... sane
A
The kinked demand curve model has

been criticised on several counts:-

Q There are also some other valid
explanation for price rigidity, such
as nationally advertised prices,
catalogued prices, reluctance to
disrupt customers relations, and
fears that recurrent price cuts may
trigger a price war.

A The model does not explain how the
firm arrive at the kink in the first
place.

10. Conclusion:

In conclusion, we can opine that mutual
interdependence among the firms and price
rigidity are two typical features in oligopoly
market. Although the firms are rivals, they
are mutually interdependent. No firms likes
to resort price change which will harm his
business. Hence price competition is not
significant is oligopoly market.

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