kinky demand curve model

7/27/2019 Kinky Demand Curve Model

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KINKED DEMAND CURVE

SUBMITTED BYDEBOJIT NATH (23)

MBA IST SEMESTER (SEC- A)


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INTRODUCTION

The kinked demand curve was first used byPaul.M.Sweezy to explain price rigidity.

The assumption behind this theory of kinked demand is that each

oligopolistic will act and react in a way that keeps condition tolerable forall members of the industry.

Such a situation is most likely to occur where products are quite similarand, therefore their prices almost same.

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If one firm is selling at a price lower than that of its competitors, thesecompetitors will be compelled to reduce their prices to match this firmsprice.

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

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.

The oligopoly firm probably realises that it is better to accommodate itsrival rather than start a price war.

So in non-collusive oligopoly the prices is tend to be sticky i.e, there is aprice rigidity.

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Contd

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The most significant aspect of the solution of an oligopoly situation is

the presence of kink in the demand curve of the firm.

The kink shows that price reduction by a firm is followed by its

rival(competitors).

Therefore firm will not move away from the kink.

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The Key characteristics of an Oligopolistic Market there are few buyers and large number of sellers

Few firms sell branded products which are close substitutes of each other.

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

government rules / regulations or ownership of scare resources.

Firms are interdependent for decision making.

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

The sellers are the price makers and not price takers, since the few sellers mutually dominate

the pricing decisions.

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

It is believed that if an 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 at E).

For a price reduction below P, the share of the market demand curve DE 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*

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ILLUSTRATION- 1


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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 throughdiscontinuous HR through point E 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 toMC due to rise in cost the output remain unchanged since

the new MC also passes through HR

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REASONS FOR PRICE RIGIDITY

Fig:-Changes in the cost within limits do notaffect the oligopoly price

REASON-1


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Likewise when demand condition changesthe price may remain stable.

The demand for oligopolist from dkD todkD the marginal cost curve MC also cutsthe new MR curve within the gap

Thus same price OP continues to

prevail(Mk=Mk) in the oligopolistic firm

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CHANGES IN DEMAND DO NOT AFFECT THE OLIGOPOLY PRICE

REASON 2


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Criticism /drawbackThe kinked demand curve model has beencriticised on several counts:-

There are also some other validexplanation for price rigidity, such asnationally advertised prices, cataloguedprices, reluctance to disrupt customersrelations, and fears that recurrent pricecuts may trigger a price war.

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

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Conclusion:In conclusion, we can opine that mutualinterdependence among the firms and price rigidityare two typical features in oligopoly market.Although the firms are rivals, they are mutuallyinterdependent. No firms likes to resort pricechange which will harm his business. Hence pricecompetition is not significant is oligopoly market.

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kinky demand curve model

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