Explanation of kinked demand curve. Microeconomics 2019-02-19

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Kinked

explanation of kinked demand curve

But, there is an incentive for firms to exceed quota and increase output. Therefore, for a price cut, demand is price inelastic. In other words, in many oligopolistic industries prices remain sticky or inflexible, that is, there is no tendency on the part of the oligopolists to change the price even if the economic conditions undergo a change. Second, empirical research has not verified the predictions of the model. The price is reduced to below cost price, a definite loss leader, so that the competitor cannot cope.


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Oligopoly Diagram

explanation of kinked demand curve

From what has been said above, it is easy to see why an oligopolist confronting a kinked demand curve will have no incentive to raise its price or to lower it. 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. Also, competitive pressures encourage them to innovate. The price-raising firm will experience a large proportionate drop in sales relative to the proportionate rise in price, and so a drop in revenue. 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. What if one of the firms decided to cut its price to 80p a litre? From above, it is clear that the kinked demand curve analysis of oligopoly explains stability in price in the face of falling costs or declining demand, whereas, price are likely to rise when either the costs rise or demand increases.

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Microeconomics

explanation of kinked demand curve

If demand was elastic, then the situation where all three firms drop their price might result in an increase in revenue for each firm. As a result, demand curve facing a firm under differentiated oligopoly is not perfectly elastic. This demand curve is relatively flat above A and relatively steep below A. It follows from the above discussion that the larger the difference between e, and e 2, i. There is no unique general solution but merely many different behavioral models, each of which reaches a different solution.

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Kinked demand

explanation of kinked demand curve

The target was probably 'The Independent', but they seem to have survived. Definition of oligopoly An oligopoly is an industry dominated by a few large firms. Collusion is illegal and firms can be fined. This is very difficult, so firms in oligopoly often avoid this uncertainty by colluding. Hence, all three firms face a demand curve that is elastic quite flat above 80p and inelastic fairly steep below 80p.

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Oligopoly

explanation of kinked demand curve

Thirdly, the rival organizations may follow price cut, but not price hike. Such an analysis has been made by Paul Sweezy in 1939. This is illustrated in Fig. It can also expect other firms not to match an increase in price because of their desire to increase their sales at its expense. Collusion and game theory is more complex if we add in the possibility of firms being fined by a government regulator. This is because if the organization would increase the prices, the rival organizations would decrease their prices and gain the market share.

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Oligopoly Diagram

explanation of kinked demand curve

Now, this output will be allocated among the organizations. However, barriers to entry are less than monopoly. If you do Business Studies A level as well, you have probably heard of the 4 Ps marketing mix. Therefore demand will only increase by a small amount. The big problem, of course, is the fact that it is tempting for a member of the cartel to cheat! This would result in producing the kinked demand curve. The price P will tend to remain stable or rigid as every member of the oligopoly will not see any gain in lowering it or in increasing it.


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The Kinked Demand Curve Model of Oligopoly Pricing

explanation of kinked demand curve

Our mission is to provide an online platform to help students to discuss anything and everything about Economics. And in spite of the fact that it can sell 1,000 more units, its total revenue will fall from Rs. In other words, cartel can be defined as a group of organizations that together make pricing and output decisions. The kinked demand curve hypothesis was put forward independently by Paul M. Demand is very inelastic following a price cut.

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Kinked

explanation of kinked demand curve

An Economist Among Mandarins: A biography of Robert Hall 1901-1988. Though the model explains the reluctance of oligopolists to change prices, it provides no clue as to how the original price was arrived at. Assumptions of the Kinked Demand Curve Model : This model was developed independently by Prof. This is because the other two firms knew that they would gain extra sales if they left their price at 85p, so they did not follow the price rise. In this lesson we take a graphical approach to oligopoly, and seek to explain why prices tend not to fluctuate up or down in oligopolistic markets.

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