In an oligopolistic market, firms cannot have a fixed demand curve since it keeps changing as competitors change the pricesquantity of output. In this article, we will look at the kinked demand curve hypothesis. The segment above the prevailing price level is highly elastic. The paper starts with a discussion of the traditional explanations of the kinked demand curve. The kinked demand curve theory of oligopoly assumes that rival firms. In particular, the upper section of the kinked demand curve has a higher price elasticity than the lower part.
They are distinguished by a hypothesized concave bend with a discontinuity at the bend the kink. This kinked curve happens because in oligopolies they are facing competition. Then it is shown that the equilibrium price is attained at a kink of the demand curve of the leader, implying rigidity of price. By formalizing the kinked demand theory as an extensive form game i reinterpret it as a theory of price determination when firms can respond without delay to undercutting. 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. Our paper provides a game theoretic interpretation of the old kinked demand curve theory which unlike. The kinked demand curve model assumes that a business might face a dual demand curve for its product based 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. One of the oldest and most popular approach to kinked demand curves is sweezys oligopoly model sweezy, 1939. Advantages and disadvantages of the oligopoly market system. Overview and quantity competition with large fixed costs by eric maskin and jean tirole the paper introduces a class of alternatingmove infinitehorizon models of duopoly. A rm conjectures that its rivals will match its price if it reduces the price, but will not match its price if it initiates a price increase.
Kinked demand oligopoly excerpt from class youtube. The kinked demand curve theory is an economic theory regarding oligopoly and monopolistic competition. Another explanation of the rigidity of oligopoly prices is offered by the abnormal shape of an oligopolies marginal revenue curve, when it faces a kinked demand curve. The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel. Assuming that some customers observe at no cost only the price of the store they happen to be at gives rise to a kink in. Kinked demand curve essay example graduateway an premise of the kinked demand curve theory is that an oligopolistic house will confront two demand curves as a consequence of a crick. The following section considers the construction of a kinked demand based on the behavioural assumption of psychological sensitivity. In a cartel member firms may be given a fixed amount to produce. Oligopoly traits a theory relating to possible payoffs during the decision making process.
Unit 3 oligopoly and the kinked demand theory flashcards. The kinked demand curve model also called sweezy model posits that price rigidity exists in an oligopoly because an oligopolistic firm faces a kinked demand curve, a demand curve in which the segment above the market price is relatively more elastic than the segment below it. The fourfirm concentration ratio will rise following. There is a kink at the point r p 1, q 1 on this curve, because the curve consists of a segment dr of the relatively flatter curve dd and another segment rd of the relatively steeper curve dd. This model of oligopoly suggests that prices are rigid and that firms will face different effects for both increasing price or decreasing price. In terms of game theory, and taking a simple 2 firm and 2 choice payoff matrix, the choice taken will often depend upon whether the airline is optimistic or pessimistic about what rivals do, in a similar way to prisoners in the prisoners dilemma. What is the kinked demand curve model of oligopoly. A cartel is defined as a group of firms that gets together to make output and price decisions.
Shortcomings of the kinkeddemand model include essay. Oligopoly characteristics economics online economics. 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. According to the kinked demand curve hypothesis, the demand curve facing an oligopolist has a kink at the level of the prevailing price. Assuming that some customers observe at no cost only. The segment below the prevailing price level is inelastic. The elasticity of demand, and hence the gradient of the demand curve, will be also be different. The demand curve will be kinked, at the current price. Therefore this suggests that prices will be rigid in oligopoly. If a few firms dominate an industry the market is known as a monopolistic competition b competitively monopolistic c duopoly d oligopoly. This essay will discuss the advantages and disadvantages of the oligopoly market system. Proposed by paul m sweezy many oligopolistic firms exhibit high degree of price rigidity or sickness. Kinked demand curve model with criticisms oligopoly.
When the possibility of entry is taken into account, the. The market demand curve that each oligopolist faces is determined by the output and price decisions of the other firms in the oligopoly. This theory tries to explain the rationale behind the price rigidityin an oligopoly market. View notes chapter 11 from econ 2002 at johnson and wales university shortcomings of the kinked demand model include essay. The kinked demand curve model assumes that a business might face a dual demand curve for. With regards to oligopoly it can provide insights into how likely collusive behavior will succeed. A kinked demand curve model is explained with the help of figure2. When it was created, the idea fundamentally challenged classical economic tenets such as efficient markets and rapidly changing prices, ideas that underlie basic supply and demand models. There is limited realworld evidence for the kinked demand curve model. Pdf the kinked demand curve, facilitating practices, and. In this model, every organization faces two demand curves.
Kinked demand curve model price rigidity graph example. The kinked demand curve model predicts that usually oligopolists will not find either prospect very attractive. First, we test the theory of the kinked concave demand curve. Learn vocabulary, terms, and more with flashcards, games, and other study tools. So they will have a tendency not to change the price at all. It was originally formulated as a theory of price rigidity. The theory can be criticised for not explaining why firms start out at the equilibrium price and quantity. Kinked demand curve model of oligopoly with diagram. I provide a microfounded theory for one of the oldest, but so far informal, explanations of price rigidity. The kinkeddemand curve theory is an economic theory regarding oligopoly and monopolistic competition. Sweezy and hence this is also called as sweezys curve. The diagram above suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve. These two early theories constitute the classic approach to demand curve which relates to the theory of the firm.
Kinked demand was an initial attempt to explain sticky prices. Game theory kinked demand curvedemand curve p elastic inelastic p d or d q or q q or q kinked demand curvedemand curve p elastic. Yet, existing models with price rigidities often lack compelling microfoundations. Game theory and the kinked demand curve can help analyse price reductions in oligopolistic markets.
In your own words, describe why firms face this situation. Oligopoly and strategic pricing in this section we consider how. Collusive and noncollusive oligopoly what is an oligopoly. Mba2 oligopoly kinked demand curve assignment assignment directions. B a perfectly elastic demand curve c a downward sloping demand curve d none of these.
The roots of supermarkets are the cooperative of the nineteenth century. Start studying unit 3 oligopoly and the kinked demand theory. Assuming that some customers observe at no cost only the price of the store they happen to be at gives rise to a kink in firms demand curves. Hall and hitch, 1939 has been one of the staples of oligopoly theory. One example of a kinked demand curve is the model for an oligopoly. The slope of a kinked demand curve differs in different conditions, such as price increase and price decrease. It has been observed that many oligopolistic industries exhibit an appreciable degree of price rigidity or stability. This is demand curve for oligopolistic competition, in which there are less than 10 producers and there are huge nu. We investigate whether the price elasticity of demand does indeed rise in the. Therefore, the first derivative point is undefined and leads to a jump discontinuity in the marginal revenue curve classical economic theory assumes that a profitmaximizing. Even when there is a large rise in marginal cost, price tends to stick close to its original, given the high price elasticity of demand for any price rise. Facilitating practices, and oligopolistic coordination.
The kinked demand curve revisited ryerson university. This fact file will focus on the use of game theory in understanding the strategic decisions of firms in oligopoly. Price competition, kinked demand curves, and edgeworth cycles by eric maskin and jean tirole1 we provide game theoretic foundations for the classic kinked demand curve equilibrium. Key theorists cournots theory explains how if the barriers to entry are low, then the. Price rigidity characteristics of oligopolistic market by which firms are reluctant to change price even if their cost and. A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices. Supermarket has brought into the service for man for long.
While the kinked demand curve has been around for fifty years, it is largely discredited today. Likewise, the kinked demand curve theory explains that even when the demand conditions change, the price may remain stable. Theory kinked demand curves and traditional demand curves are similar in that they are both downwardsloping. The point of the crick is the constituted market monetary value within the industry. Mba2 oligopoly kinked demand curve assignment assi. The idea of the kinked demand curve is based on the different perception of the firms in imperfect markets. 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. Since an oligopolist is not aware of the demand curve, economists have designed various priceoutput models based on the behavior pattern of other firms in the industry. Use the graph pictured to calculate total revenue in the elastic and inelastic portions of the demand curve at the price and quantity points specified to explain the theory.