Kinked Demand Curve

September 18, 2024 Post a Comment

Kinked demand curve

The oligopolist faces a kinked‐demand curve because of competition from other oligopolists in the market. If the oligopolist increases its price above the equilibrium price P, it is assumed that the other oligopolists in the market will not follow with price increases of their own.

What are the assumptions of kinked demand curve?

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. The result is that for each firm the portion of the demand curve above the current price is elastic and the portion below the curve is inelastic.

What is kinked demand theory?

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. The curve is more elastic above the kink and less elastic below it. This means that the response to a price increase is less than the response to a price decrease.

Why kinked demand is formed?

A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices. One example of a kinked demand curve is the model for an oligopoly.

What are the limitations of kinked demand curve?

Drawbacks of Kinked Demand Curves First, it does not explain the mechanism of establishing the kink in the demand curve. It also does not state how the kinked demand curve is reformed when price/quantity changes. Most of the time, other oligopolists follow pricing decisions when one oligopolist increases the price.

Who proposed kinked demand?

The kinked demand curve was developed by American economist Paul Sweezy and has become crucial in oligopoly theory. It illustrates the interdependent behaviour of firms in oligopolistic market structures. The kinked demand curve illustrates the interdependence of firms in an oligopoly market.

What are its limitations the kinked demand curve model?

A major limitation is that the kinked-demand model does not explain how the starting price is determined. Price rigidity may occur in oligopolistic markets because firms want to avoid destructive price wars. Managers learn from experience that cutting prices does not lead to lasting increases in profits.

What is price rigidity and kinked demand curve?

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.

How does the kinked demand curve explain price stability?

The model of the kinked demand curve suggests prices will be stable. Firms don't want to increase prices because they will see a sharp fall in demand. 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.

What is the impact of price rise on kinked demand curve?

Impact of price rise If a firm increases the price, then it becomes more expensive than rivals and therefore, consumers will switch to its rivals. Therefore for a price rise, there is likely to be a significant fall in demand.

Why oligopoly has price rigidity?

Why the price rigidity? As can be seen above, a firm cannot gain or lose by changing its price from the prevailing price in the market. In both cases, there is no increase in demand for the firm which changes its price. Hence, firms stick to the same price over time leading to price rigidity under oligopoly.

What is the shape of MR curve in kinked demand curve?

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. 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.

Is oligopoly elastic or inelastic?

Oligopolistic market: Kinked demand curve model If the assumptions hold, then: The firm's marginal revenue curve is discontinuous (or rather, not differentiable), and has a gap at the kink. For prices above the prevailing price the curve is relatively elastic. For prices below the point the curve is relatively

What are the 4 characteristics of oligopoly?

Raised barriers to entry, price-making power, non-price competition, the interdependence of firms, and product differentiation are all oligopoly characteristics.

Why cement industry is oligopoly?

The global cement industry can be characterised as a network of regional oligopoly markets. As cement is a relatively homogenous product globally, differences in world market prices largely reflect differences in local production costs and high transportation costs. Several other factors are key: Cost pass-through.

What is pure oligopoly?

Pure or Perfect Oligopoly: If the firms in an oligopoly market manufacture homogeneous products, then it is known as a pure or perfect oligopoly. Even though it is rare to find oligopoly firms with homogeneous products, industries like steel, cement, aluminum, etc., come under pure oligopoly.

Why MR curve is horizontal?

Marginal revenue is also horizontal because the increase in revenue from producing one more unit of output is equal to the price of the good meaning it remains constant, thus horizontal.

Why MR is downward sloping?

The marginal revenue curve is often downward sloping because there is most often an economically inverse relationship between price and quantity. As a company decreases the price of its product, more units will likely be demanded; as the price is increased, demand often decreases.

What is the shape of AR and MR?

Both AR and MR curves are indicated by the same line. And it is a horizontal straight line parallel to the X-axis.

Is Coca-Cola and oligopoly?

Coca-Cola and Pepsi are oligopolistic firms that collude to dominate the soft drink market. In this scenario, both firms have the choice to set their prices high or low, and the potential profits for both firms are listed in the matrix.