The kinked demand curve is a fundamental model in microeconomics used to explain price stability in oligopoly markets. Economics students at both A/L and university level study the kinked demand curve to understand why firms in industries with few competitors tend to avoid changing prices even when costs change.
The theory of the kinked demand curve was developed by Paul Sweezy to explain price rigidity in oligopoly markets. The model suggests that firms expect competitors to respond differently to price increases and price decreases, which creates a demand curve with a kink at the current market price.
The kinked demand curve remains an important tool for understanding pricing behavior in industries such as telecommunications, airlines, and retail markets. Despite the development of modern game theory models, the kinked demand curve continues to be widely taught in economics courses around the world.
This article provides a complete explanation of the kinked demand curve including definition, assumptions, diagram explanation, examples, criticisms, and exam guidance.
Definition of Kinked Demand Curve
Featured Definition
The kinked demand curve is an economic model that explains price rigidity in oligopoly markets. It assumes that firms believe competitors will match price decreases but ignore price increases, creating a demand curve with a kink at the current market price. This leads firms to maintain stable prices.
Meaning of Kinked Demand Curve
A kinked demand curve is a demand curve that has a sudden change in slope at the prevailing market price.
The kinked demand curve reflects the interdependence of firms in oligopoly markets.
In oligopoly markets:
- There are few sellers
- Firms are mutually dependent
- Competitors’ reactions influence decisions
Because firms must consider competitor behavior, the kinked demand curve becomes an important tool for understanding price decisions.
Historical Background
The kinked demand curve theory was introduced by Paul Sweezy in 1939 as an explanation for price rigidity in oligopoly markets.
Later economists expanded the study of oligopoly behavior, including Edward Chamberlin, who developed theories of monopolistic competition, and George Stigler, who studied oligopoly behavior and price competition.
Although modern economics often uses game theory to analyze oligopoly markets, the kinked demand curve remains an essential introductory model.
Assumptions of the Kinked Demand Curve
The kinked demand curve model is based on several assumptions.
Oligopoly Market Structure
The kinked demand curve applies only to oligopoly markets where a small number of firms dominate the market.
Characteristics include:
- Few large firms
- High barriers to entry
- Mutual interdependence
Firms must consider competitors before changing prices.
Asymmetric Competitor Reactions
The most important assumption of the kinked demand curve is asymmetric reaction.
Firms believe:
- Competitors will match price decreases
- Competitors will ignore price increases
This belief determines the shape of the kinked demand curve.
Profit Maximization
Firms using the kinked demand curve aim to maximize profits.
They choose output where:
Marginal Revenue = Marginal Cost
However, the kinked demand curve produces special results.
Shape of the Kinked Demand Curve
The kinked demand curve has two segments.
Upper Segment – Elastic Demand
Above the kink:
- Demand is elastic
- Small price increases cause large decreases in quantity demanded
Reason:
Consumers switch to competitors.
Lower Segment – Inelastic Demand
Below the kink:
- Demand is inelastic
- Large price decreases cause small increases in quantity demanded
Reason:
Competitors match price reductions.
The Kink Point
The kink point represents:
- Current market price
- Current output level
The kinked demand curve suggests that firms prefer to remain at this point.
Changing price creates uncertainty.
Therefore firms maintain stable prices.
Marginal Revenue and the Kinked Demand Curve
One of the most important features of the this curve is the marginal revenue curve.
Discontinuous Marginal Revenue Curve
This curve produces a marginal revenue curve with a vertical gap.
This gap is a key feature of the model.
Because of this gap:
- Marginal cost can change
- Price remains constant
Explanation
If marginal cost changes within the gap:
- Equilibrium price does not change
This explains price rigidity.
Price Rigidity in Oligopoly
Price rigidity is the main conclusion of the kinked demand curve model.
Meaning
Price rigidity means prices remain stable over time.
Even when:
- Costs change
- Demand changes
Prices often remain constant.
Price Increase Scenario
If a firm increases price:
- Competitors keep prices unchanged
- Customers switch to competitors
- Sales fall sharply
Price Decrease Scenario
If a firm decreases price:
- Competitors reduce prices
- Industry profits fall
Result
Firms avoid price changes.
This creates price rigidity.
Diagram Explanation
Students frequently need to draw the kinked demand curve diagram. Reference: https://en.wikipedia.org/wiki/Kinked_demand
Step 1
Draw a downward sloping demand curve.
Add a bend in the middle.
This represents the kink.
Step 2
Label the kink point:
- Price (P)
- Output (Q)
Step 3
Label upper section:
Elastic demand.
Step 4
Label lower section:
Inelastic demand.
Step 5
Draw marginal revenue curve with a gap.
This gap explains price rigidity.
Real World Examples
Airlines
Airlines often maintain similar prices.
If one airline increases price:
Customers move to competitors.
If one airline reduces price:
Competitors follow.
This behavior fits the kinked demand curve model.
Retail Chains
Large retail chains often maintain similar prices.
Price competition is limited.
This reflects kinked demand curve behavior.
Telecommunications
Telecommunications companies often maintain stable pricing.
Price changes are rare.
This reflects the kinked demand curve model.
Advantages of the Kinked Demand Curve
Explains Price Stability
It explains stable prices.
This matches real markets.
Realistic Behavior
It reflects business behavior.
Firms consider competitors.
Simple Model
It is easy to understand.
This makes it useful for teaching.
Limitations of the Kinked Demand Curve
Does Not Explain Original Price
The kinked demand curve explains price rigidity but not initial price determination.
Unrealistic Assumptions
Competitors do not always behave as expected.
Sometimes firms start price wars.
Difficult to Test
Empirical evidence is limited.
It is difficult to measure the kinked demand curve in real markets.
Criticisms by Economists
Some economists have criticized the kinked demand curve.
Lack of Predictive Power
The kinked demand curve explains stable prices but does not predict price levels.
Game Theory Models
Modern economists often use game theory instead of the kinked demand curve.
Game theory explains strategic decisions more accurately.
Limited Evidence
Some economists argue that there is little statistical evidence supporting the kinked demand curve.
Despite criticism, the kinked demand curve remains widely taught.
Common Mistakes Students Make
Mistake 1
Confusing elastic and inelastic sections.
Correct:
- Above kink → elastic
- Below kink → inelastic
Mistake 2
Forgetting marginal revenue gap.
This is essential.
Mistake 3
Not explaining competitor reactions.
Competitor reaction is the key idea.
Exam Answer Structure
Definition
The kinked demand curve is a demand curve with a kink at the current price that explains price rigidity in oligopoly markets.
Explanation
- Competitors match price decreases
- Competitors ignore price increases
- Elastic above kink
- Inelastic below kink
Diagram
Include:
- Kinked demand curve
- Marginal revenue gap
Conclusion
The kinked demand curve explains price stability in oligopoly markets.
Quick Revision Summary
Key points:
- Applies to oligopoly
- Kink at current price
- Elastic above kink
- Inelastic below kink
- MR gap
- Price rigidity
Question & Answers
What is kinked demand curve in simple terms?
The kinked demand curve explains why firms in oligopoly markets keep prices stable due to competitor reactions.
Who developed kinked demand curve?
The kinked demand curve was developed by Paul Sweezy.
Why is demand elastic above the kink?
Demand is elastic because customers switch to competitors when prices increase.
Why is demand inelastic below the kink?
Demand is inelastic because competitors match price decreases.
Why is price rigid in oligopoly?
Price is rigid because firms avoid price increases and price decreases.
