The kinked demand curve is a microeconomic model that explains why prices in oligopolistic markets often remain stable despite changes in production costs. The model illustrates how firms expect that their competitors will match price decreases but not price increases, leading to a demand curve that is more elastic for price increases than for price decreases.
Historical Context
The kinked demand curve model was first introduced by Paul Sweezy in 1939 as a way to understand price rigidity in oligopolistic markets. Since oligopolies consist of a few firms dominating the market, each firm’s pricing decisions are highly dependent on the actions of its competitors.
Key Concepts
- Oligopoly: A market structure where a few firms dominate and each firm’s actions affect the others.
- Elasticity: A measure of how much the quantity demanded responds to a change in price.
- Price Stickiness: The resistance of prices to change despite shifts in supply or demand.
Types/Categories
- Non-cooperative Oligopolies: Firms do not collude and each firm independently tries to maximize its own profit.
- Cooperative Oligopolies: Firms collude to set prices or output to maximize combined profits.
Detailed Explanation
In an oligopolistic market, firms are highly interdependent. The kinked demand curve hypothesizes that:
- If a firm raises its price, competitors will not follow, causing a significant loss of market share, making the demand curve more elastic for price increases.
- If a firm lowers its price, competitors will match the price cut to avoid losing their market share, resulting in a less elastic demand curve for price decreases.
Mathematical Models and Formulas
In the kinked demand curve model, the Marginal Revenue (MR) curve has a discontinuity at the kink:
Where \(a\) and \(b\) are constants, \(Q\) is quantity, and \(Q^*\) is the quantity at the kink.
Charts and Diagrams
graph TD
A[Price Increase - High Elasticity]
B[Price Decrease - Low Elasticity]
C[(Kink Point)]
subgraph Kinked Demand Curve
A --> C
B --> C
end
Importance and Applicability
The kinked demand curve model is crucial for understanding price rigidity in real-world markets. It explains why prices in oligopolistic markets do not fluctuate as drastically as those in more competitive markets.
Examples
A practical example is the petrol market, where a few firms dominate and prices often remain stable despite changes in crude oil prices.
Considerations
- Real-world applicability may be limited as not all oligopolistic markets exhibit kinked demand.
- The assumption that firms match price cuts but not price increases may not always hold true.
Related Terms
- Game Theory: A framework for understanding strategic interactions among firms.
- Collusion: An agreement between firms to set prices or production levels.
Comparisons
- Kinked Demand vs. Linear Demand: A linear demand curve assumes a constant elasticity, whereas the kinked demand curve has varying elasticity depending on price direction.
- Kinked Demand vs. Perfect Competition: In perfect competition, firms are price takers and prices are highly responsive to changes in demand or supply, unlike in oligopolistic markets.
Interesting Facts
- The kinked demand curve model was one of the first to incorporate expectations and strategic interactions into economic models.
Inspirational Stories
Paul Sweezy, despite skepticism from many economists, continued to develop his theories on market structures, greatly influencing later research in oligopoly and industrial organization.
Famous Quotes
“In economic theory, there is nothing to show that prices in a market are rigid and inflexible.” - Paul Sweezy
Proverbs and Clichés
- “The more things change, the more they stay the same.” - Reflects the price rigidity in oligopolistic markets.
Expressions, Jargon, and Slang
- Sticky Prices: Prices that do not change easily despite shifts in supply and demand.
- Price Rigidity: Another term for sticky prices.
FAQs
-
Why do prices tend to be sticky in oligopolistic markets?
- Due to the kinked demand curve, where firms expect competitors to match price cuts but not price increases.
-
Can the kinked demand curve apply to all oligopolistic markets?
- Not necessarily; it depends on the market conditions and competitive behavior of the firms.
References
- Sweezy, P. M. (1939). “Demand under Conditions of Oligopoly”. Journal of Political Economy, 47(4), 568-573.
- Perloff, J. M. (2020). Microeconomics. Pearson.
Summary
The kinked demand curve model provides insightful explanations for price stickiness in oligopolistic markets. By considering the interdependent nature of firms and their strategic pricing decisions, the model highlights the complexities of real-world market behaviors. Understanding this model helps economists and business strategists predict pricing patterns and market stability.
Remember to stay updated with the latest research and adapt economic theories to evolving market conditions for a comprehensive understanding of market dynamics.
