A kinked demand curve represents the behavior pattern of oligopolistic organizations in which rival organizations lower down the prices to secure their market share, but restrict an increase in the prices. These two different types of reaction of the competitors to the increase in price on the one hand and to the reduction in price on the other make the portion of the demand curve above the prevailing price level relatively elastic and the lower portion of the demand curve relatively inelastic. In an oligopoly, firms often compete on non-price competition. . If you do Business Studies A level as well, you have probably heard of the 4 Ps marketing mix.
This is why other models have been proposed to explain how oligopolies might work for example, the Stackelberg model. Implication of the Kinked Demand Curve Model: The most important implication of the kinked demand curve model is that in oligopolistic market structure firms could experience substantial shifts in marginal costs and still not vary their prices. As has been explained above, in the context of decreased demand, price in kinked demand curve theory is likely to remain sticky. These barriers to entry may include brand loyalty or economies of scale. In this model, every organization faces two demand curves. Similarly, the marginal revenue that the oligopolist actually receives is represented by the marginal revenue curve labeled adef. This first diagram shows the revenue curves and how they are derived.
The points of intersection E 1 and E 2 are the equilibrium levels of the organizations, A and B, respectively. The model advocates that the behavior of oligopolistic organizations remain stable when the price and output are determined. The oligopolist who raises his price will be able to retain only those customers who either have a strong preference for his product if the products are differentiated or who cannot obtain the desired quantity of the product from the competitors because of their limited productive capacity. In recent years, it appears that the quality newspaper market is a good example. When oligopolists follow each others pricing decisions, consumer demand for each oligopolist's product will become less elastic or less sensitive to changes in price because each oligopolist is matching the price changes of its competitors. However, the reaction pattern of the rivals, as given by assumption v , is able to explain why the prices would not tend to change, i.
Why the Kink in the Demand Curve? Kinked demand curve limitations In the above kinked demand curve example we put the kink at a certain price and quantity. Basically, the kinked demand curve model still holds, it's just that the kink point A has shifted up a bit. Basically, it is where one firm cuts its price, the others follow and perhaps cut theirs by a little bit more, and so on. This is illustrated in Fig. On the basis of the above discussion, we may conclude that in the kinked demand curve model of oligopoly, the firm would not consider it profitable or rational to change the prevailing price of its product because of the assumption v relating to the reaction pattern of its rivals.
In other words, cartel can be defined as a group of organizations that together make pricing and output decisions. Sweezy on the one hand and Profs. Analysis of the Kinked Demand Curve Model : In the oligopoly model under discussion, the properties of the kinked demand curve as well as its significance are especially discussed. Further, it is worth mentioning that the oligopolist confronting a kinked demand curve will be maximising his profits at the current price level. Let us suppose that initially the price of the product of the firm is p 1 or Op 1 and the demand for the product is q 1 or Oq 1 If the firm now increases its price from p 1, the rival firms would keep their prices unchanged according to assumption v of this model. All this price rigidity means that firms do not compete on price, so they have to resort to non-price competition see later. If the oligopolistic organization increases the price and rivals do not follow it, then consumers may switch to rivals.
There has to be a kink in the demand curve at price 80p. The kinked demand curve hypothesis was put forward independently by Paul M. Therefore, for a price cut, demand is price inelastic. However, the seller may be reluctant to raise prices because competitors might not follow this lead. This agreement is known as collusion, which is opposite to competition. Quality is an important area of competition.
Therefore, price and output would remain stable. This is because, in this case, as the firm decreases or increases the price, its product does not become neither relatively cheaper nor dearer. There is hardly any disposition to lower the price when there is decline in demand or in costs, but the price may be raised in response to increased demand or to rising cost. So price increase is not at all desirable in such a situation. Commenting upon kinked demand curve theory Prof.
Also, competitive pressures encourage them to innovate. On the other hand, if price falls, the rivals would also reduce their prices, thus, the sales of the oligopolistic organization would be less. The competitive reaction pattern assumed by the kinked demand curve oligopoly theory is as follows: Each oligopolist believes that if he lowers the price below the prevailing level, his competitors will follow him and will accordingly lower their prices, whereas if he raises the price above the prevailing level, his competitors will not follow his increase in price. A fall in total revenue under unchanged cost conditions is equivalent to a fall in total profit. In recent years, we have seen price wars in the following industries: newspapers see above , fast food McDonald's verses Burger King , mobile phones especially between the four main networks and package holidays. The model does not explain how these prices have been determined. Note that the kink is the equilibrium, which in our example is the 80p litre of petrol.
This makes sense if you remember how all marginals and averages are linked. While this is one the main oligopoly models used by economists to explain the behavior of firms within the monopoly, it has a serious flaw. These happy competitors will have therefore no motivation to match the price rise. Therefore, economists found it extremely difficult to propound any specific theory for price and output determination under oligopoly. Since the oligopolist will not gain a large share of the market by reducing his price below the prevailing level, and will have substantial reduction in sales by increasing his price above the prevailing level, he will be extremely reluctant to change the prevailing price. Thus, the rivals would gain control over the market. These expectations rest on the normal situation of substantial excess production capacity available in the industry.
Collusion Model-The Cartel : In oligopolistic market situations, organizations are indulged in high competition with each other, which may lead to price wars. The greater the difference in the two elasticities, the greater the length of the discontinuity. The demand is more elastic. However, barriers to entry are less than monopoly. This is why advertising is so important. Also, we assumed with petrol that demand in the market, as a whole was inelastic. The other two firms know this is going to happen following the price cut, so they match the price cut see price wars later.