It is homogenous and consumers are price sensitive. If one petrol station increased the price there would be a shift to other petrol stations. However, if one petrol station cuts price, other firms may feel obliged to follow suit and also cut price — therefore a price cut would be self-defeating for the first firm. How realistic is the kinked demand curve in practice? In many oligopolies, firms may have a degree of brand differentiation.
Mobile phone companies can increase the price but consumers are willing to pay because the price is not the dominant factor. Some petrol stations may increase price and not see elastic demand because they have the best location.
Firms may not want to defend market share. Rather than getting pulled into a price war, some firms may not respond to price cut but concentrate on non-price competition to retain an advantage. Other examples of the kinked demand curve It is not just in an oligopoly where there is potential kinked demand curve.
In the market for an addictive drug like cocaine. If the price is cut, it may encourage first-time users to try. However, once addicted, if the price rises, then demand will be price inelastic they will be willing to pay the higher price to get their drug fix Related Oligopoly.
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This cookie is used to keep track of the last day when the user ID synced with a partner. This ID is used to continue to identify users across different sessions and track their activities on the website. In an oligopolistic market, firms do not have a fixed demand curve.
Yet, the oligopolist must know their demand curve to maximize profits. Economists, thus, have developed many price-output models to explain the oligopoly market behaviour. The two most popular ones of them are- kinked demand curve theory and cartel theory. Here, in this blog, we will discuss the kinked demand curve at length.
The kinked demand curve theory is a theory about oligopolistic and monopolistic competition. It was brought forward by Paul Sweezy as the first attempt to explain sticky prices. Like traditional demand curves, kinked demand curves are downward sloping. This kink is nothing but a discontinuity at a concave bend and this kink is what sets it apart from the traditional demand curves. Now let's find out why these kinks exist in the first place. For a long time, it has been observed that prices are mostly "sticky" in the oligopolistic markets.
Prices remained inflexible even when costs fell. This drove both economists and industrialists crazy. Economists racked up their brains all day but could not explain this strange phenomenon. Not to mention, this was extremely bad for business. In came Sweezy, an American economist with his kinked demand curve theory.
Then, economists and industrialists cheered alike. Consequently, the demand for the oligopolist's output falls off more quickly at prices above P ; in other words, the demand for the oligopolist's output becomes more elastic. If the oligopolist reduces its price below P , it is assumed that its competitors will follow suit and reduce their prices as well. The oligopolist will then face the relatively less elastic or more inelastic market demand curve MD 2.
The oligopolist's market demand curve becomes less elastic at prices below P because the other oligopolists in the market have also reduced their prices. 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. First, it does not explain how the oligopolist finds the kinked point in its market demand curve.
The possibility of collusive behavior is captured in the alternative theory known as the cartel theory of oligopoly.
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