Kinked demand curve model of oligopoly with diagram. A kinkeddemand theory of price rigidity blocnotes eco. Though a change in population is better represented by a horizontal shift, if the macroeconomy is less stable than costs of extracting crude oil and world population, shifts in cost and demand taken together will cause greater instability in the price of crude oil with a kinked demand curve than with a smooth curve. Firms may not seek to maximise profits, but prefer to increase market share and so be willing to cut prices, even with inelastic demand. Here, i argue that opec as a whole faces a kinked demand curve. That is, firms with market power have downward sloping demand curves. We provide game theoretic foundations for the classic kinked demand curve equilibrium and edgeworth cycle. Hitch wrote price theory and business behavior, presenting similar ideas but including more rigorous empirical testing, including a business survey of 39. This in turn gives rise to a kinked demand curve for the leader, with kinks at the threshold levels of quantity.
Vertically shifting kinked demand curve mc d p q mr mr d p in contrast, with a nonkinked demand curve, an increase in demand would lead to an increase in price less than the full vertical shift in demand because the firm would increase output as marginal revenue intersected marginal cost at a greater quantity of output. According to the kinked demand curve theory of oligopoly. In the first place, as the demand curve or the average revenue ar curve of the firm has a kink, its mr curve cannot be obtained as a continuous curve. A kinked demand curve theory was developed in 1939 of noncollusive oligopoly. Revision flashcards for a level economics students. The kinked demand curve model scool, the revision website. The kinked demand model and the stability of cooperation sergio currarini and marco a. Feb 20, 2015 in oligopolistic market there are few big sellers and large number of sellers for example car industry few car makers but large no. Some firms may have very strong brand loyalty and be able to increase the price without demand being very price elastic. Nov 19, 2010 title slide of kinked demand curve slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising.
Remember that if you raise your price your demand will be elastic and if you lower your price demand will. One example of a kinked demand curve is the model for an oligopoly. A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices. It was originally formulated as a theory of price rigidity. This model of oligopoly suggests that prices are rigid and that firms will face different effects for both increasing price or decreasing price. Oligopoly the kinked demand curve subscribe to email updates from tutor2u economics join s of fellow economics teachers and students all getting the tutor2u economics teams latest resources and support delivered fresh in their inbox every morning. The kink, i n turn, implie s a verticaldiscontinuity in o pecs margi nal rev enue curve. Sweezy argued that an ordinary demand curve does not apply to oligopoly markets and promotes a kinked demand curve. Bhaskar university college london march 15, 2007 the kinked demand curve sweezy, 1939.
The kinked demand curve and price rigidity papers in the ssrn. In the kinked demand curve model, the firm maximises profits at q1, p1 where mrmc. The kinked demand curve, facilitating practices, and. Nov 14, 2009 my 60 second explanation of noncolluding oligopolies and the kinked demand curve model. Dec 02, 2019 it is important to bear in mind, there are different possible ways that firms in oligopoly can behave. Thus a change in mc, may not change the market price. Oligopoly the kinked demand curve linkedin slideshare. Sweezy and hence this is also called as sweezys curve. Hall and hitch, 1939 has been one of the staples of oligopoly theory. Kinked demand curve model with criticisms oligopoly. A problem with the kinked demand curve model of oligopoly a.
The kinked demand curve, facilitating practices, and oligopolistic. The kinked demand model and the stability of cooperation. There has to be a kink in the demand curve at price 80p. At high prices, the firm faces the relatively elastic market demand curve, labeled md 1 in figure. The kinked demand curve revisited ryerson university. The demand segment corresponding to lower prices is less elastic than the demand segment corresponding to higher prices. The main ingredient of our study is the idea of reactions based on shortrun commitments. Kinked demand curves and inflation persistence in a lowinflation.
Understand the characteristics of this market structure with particular reference to the interdependence of firms explain the behaviour of firms in this market structure explain reasons for collusive and noncollusive behaviour evaluate the. Hence, all three firms face a demand curve that is elastic quite flat above 80p and inelastic fairly steep below 80p. For many years, the analysis was confined to the textbook exposition of oligopoly model in which the kinked demand comes from the wellknown. Unit 3 oligopoly and the kinked demand theory flashcards. Pdf the kinked demand curve, facilitating practices, and.
A problem with the kinked demand curve model of oligopoly is that a firms beliefs about the demand curve are not always correct and firms can figure out that these beliefs are not correct. These conclusions supply a rigorous model that justifies sweezys kinked demand curve model that showed why a set of oligopolists might find the monoply. Kinked demand financial definition of kinked demand. Likewise, the kinked demand curve theory explains that even when the demand conditions change, the price may remain stable. I estimate world demand for crude oil, nonopec supply, and the effects of. A diagram illustrating kinked demand, one formulation for explaining price stability in oligopolies. The upper portion of the kinked demand curve is relatively.
Remember that if you raise your price your demand will be. The upper portion of the kinked demand curve is relatively more elastic. This paper revisits a particular behaviour for rms competing in imperfect competitive markets, underlying the well known model of kinked demand curve. Oligopoly the kinked demand curve economics tutor2u. Kinked demand curve financial definition of kinked demand curve. The key to this analysis is that competing firm s do not respond in the same way when one firm increases or decreases its price. The third paper in this series maskintirole 1987 considers competition in the absence of fixed costs cournot competition, and develops differential. A likely reason for its lesser popularity today, the theory lacks the microfoundations of its firmside counterparts. In the oligopoly model under discussion, the properties of the kinked demand curve as well as its significance are especially discussed.
For a robust interval of cost, the stackelberg leader finds it optimal to set the quantity at one of these threshold levels, thus maximizing her profit while maintaining the existing market structure. According to the kinked demand curve theory of oligopoly, each firm believes that if it lowers its price, a the government will impose price floors. Documents in econstor may be saved and copied for your personal and scholarly purposes. If one seller reduces prices its demand for product rises however other sellers seeing their demand. One of the oldest, and at a time leading, theories of price rigidity precisely locates the source of price rigidity on the customers side.
From queens college in oxford, robert lowe hall and charles j. Pdf on mar 1, 1986, ehud kalai and others published the kinked demand curve find, read and cite all the research you need on researchgate. With a kinked demand curve, a modest shift in marginal cost will not change. When we say that firm 1 is committed to a particular action in the short. This is demand curve for oligopolistic competition, in which there are less than 10 producers and there are huge nu. The kinked demand curve is a demand curve comprised of two segments, one that is relatively more elastic, which results if a firm increases its price, and the other that is relatively less elastic, which results if a firm decreases its price. If you continue browsing the site, you agree to the use of cookies on this website. A rm conjectures that its rivals will match its price if it reduces. Then it is shown that the equilibrium price is attained at a kink of the demand curve of the leader, implying rigidity of price. This first diagram shows the revenue curves and how they are derived. When the possibility of entry is taken into account, the. This theory is used to explain price stability in an oligopolistic market. A large literature documents the persistent effects of monetary policy on real.
As the number of firms in the market increase then firm demand will become more elastic. Oligopoly kinked demand curve 2007 free download as powerpoint presentation. In particular, it establishes that any equi librium must be either of the kinked demand type where the market price converges in finite time to a unique focal price or the edgeworth cycle variety in. A large empirical literature documents that inflation responds sluggishly to a monetary policy shock. My 60 second explanation of noncolluding oligopolies and the kinked demand curve model. Hitch seeks to explain how prices remain stable even when there is no collusion between oligopolies. The kinked demand curve analysis of oligopoly builds on the notion of interdependent decisionmaking to explain why prices tend to be relative stable or rigid. B it assumes that oligopolists can price discriminate. A behavioural approach to kinked demand curves munich. These conclusions supply a rigorous model that justifies sweezys kinked demand curve model that showed why a set of oligopolists might find the monoply price stable once arrived at, but did not explain why they would settle at it rather than a lower price. A kinked demand curve is made of two segments of a firms demand curve, which are separated at the price that has been established in the industry. C it implies that firms ignore the actions of each other.
Kinked demand curves, the natural rate hypothesis and. Section 4 examines the general nature of equilibrium in our model. It is comprised of two segments, one which is more elastic, which results if a firm increases its price and the other that is less elastic, which results if a firm decreases its prices. We may, therefore, begin with the properties of the mr curve of the kinked demand curve with the help of fig. The demand curve the oligopolist faces is that of two separate curves spliced together, creating a discontinuity in the mr curve. The kinked demand curve model assumes that a business might face a dual demand curve for its product based on the likely reactions of other firms to a change in its price or another variable. The kinked demand curve is a theory regarding oligopoly and monopolistic competition that explains price rigidity and price stickiness. Therefore, the kinked demand curves mitigate the distortion of aggregate output associated with the average. The kinked demand curve, one of the staples of oligopoly theory, was originally formulated as a theory of price rigidity. Market power market power is the ability of a firm to raise price and not lose all of its quantity demanded.