Kinked demand curve model

Proposed by Paul M Sweezy

Many oligopolistic firms exhibit high
degree of price rigidity or sickness.
This theory tries to explain the
rationale behind the price rigidityin
an oligopoly market.
 Price rigidity
Characteristics of oligopolistic market
by which firms are reluctant to
change price even if their cost and
demand changes.
 Price Rigidity

price rigidity Characteristic of oligopolistic markets

by which firms are reluctant to change prices even if
costs or demands change.

kinked demand curve model

Oligopoly model in which each firm
faces a demand curve kinked at the
currently prevailing price: at higher
prices demand is very elastic,
whereas at lower prices it is inelastic.
 Why price rigidity occurs?
The reaction pattern followed by an
oligopoly is firm is as follows
Each firm under this market believes that
when he lowers the price below the existing
level all others will follow-he could not enjoy
the benefit of the price cut
If he raises the price his competitors will not
follow him-he will be thrown out of the
market by the competitors
This leads to price rigidity in the market
 The demand curve facing the oligopoly firm is
Kinked meaning segmented
The demand curve has two portions----
relatively elastic portion if he raises the
price then the reaction of the consumers
will be sharp
Relatively inelastic portion---if the firm
decreases the the price the reaction of the
consumer will be low .this means that he
wont get so many consumers as he wish
since many competitors will follow him
 The ultimate result is that price
remains rigid at the kink.
 The Kinked Demand Curve
Price
Rigidity

Each firm believes that if it

raises its price above the
current price P*, none of its
competitors will follow suit, so
it will lose most of its sales.
Each firm also believes that if
it lowers price, everyone will
follow suit, and its sales will
increase only to the extent
that market demand
increases.
As a result, the firms demand
curve D is kinked at price P*,
and its marginal revenue
curve MR is discontinuous at
that point.
If marginal cost increases
from MC to MC, the firm will
still produce the same output
level Q* and charge the same
price P*.
 The Kinked Demand Curve
Price, cost
marginal W Tacit
revenue collusion
outcome MC
P* 1
MC
2

1. Any
marginal cost
in this region

MR D
Q*
Z Quantity
2. corresponds to this level
of output