What does the kinked demand curve model of oligopoly : The kinked demand curve model of oligopoly assumes that the price elasticity of demand is different above and below the prevailing market price.
Specifically, it posits that the demand curve facing an oligopolistic firm has an elastic (responsive) segment above the current price and an inelastic (unresponsive) segment below the current price.
In the context of the kinked demand curve theory, the assumptions about price elasticity of demand are as follows:
- Elastic Demand Above the Kink:
The theory assumes that if a firm raises its price above the current market price, its competitors will not follow suit and will maintain their lower prices. As a result, the firm’s demand becomes more elastic in this upper segment of the demand curve. This means that a price increase would lead to a relatively large decrease in the quantity demanded due to consumers shifting their purchases to the lower-priced competitors.
- Inelastic Demand Below the Kink:
Conversely, if the firm lowers its price below the prevailing market price, the theory assumes that competitors will match the price reduction to avoid losing market share. As a result, the demand becomes more inelastic in this lower segment of the demand curve. In this situation, a price decrease would lead to only a relatively small increase in the quantity demanded, as competitors match the price cut.
The kinked demand curve model’s assumption about differing elasticities above and below the kink helps explain why firms in oligopoly markets tend to maintain stable prices. The theory suggests that firms fear the repercussions of changing prices due to the anticipated reactions of their competitors. Price increases could result in a significant loss of market share, while price decreases might not lead to substantial gains.
It’s important to note that the kinked demand curve model is a simplification and a theoretical construct, and actual market behavior can be influenced by various factors beyond the assumed price elasticities, such as strategic interactions, competitive dynamics, and other market conditions.