The concept of a "kink" in the demand curve is predominantly associated with the oligopoly market structure, not the monopolistic competition model. While the question specifically mentions monopolistic competition, the kinked demand curve model is a theoretical construct primarily used to explain price rigidity in an oligopoly, where firms are interdependent. In monopolistic competition, firms face a downward-sloping, relatively elastic demand curve, but it typically does not feature a sharp kink.
The Kinked Demand Curve: An Oligopoly Phenomenon
In an oligopoly, a market dominated by a few large firms, each firm's pricing decisions are highly interdependent. The kinked demand curve model describes a situation where rival firms react differently to price changes, leading to an asymmetric reaction to pricing strategies. This asymmetry creates the "kink" at the current market price and quantity.
Understanding the Kink in Detail
The kink represents the point at the prevailing market price and quantity where the firm's demand curve changes slope dramatically due to differing expectations of competitor responses. This model asserts that firms anticipate two distinct reactions from their rivals:
- When a firm raises its price: Competitors are expected not to follow the price increase. They will likely hold their prices constant to capture market share from the firm that raised its price. This makes the demand curve for price increases relatively elastic, meaning a small price hike leads to a significant drop in quantity demanded.
- When a firm lowers its price: Competitors are expected to follow the price decrease to avoid losing market share. If all firms lower prices, no single firm gains a significant advantage, and the overall market price level falls. This makes the demand curve for price decreases relatively inelastic, meaning a large price cut leads to only a small increase (or even a decrease due to industry-wide revenue reduction) in quantity demanded.
The differing elasticities above and below the current price create the kink. This phenomenon contributes to price rigidity in oligopolistic markets, as firms are hesitant to change prices due to the adverse consequences of either raising or lowering them.
Summary of Competitor Reactions at the Kink
| Price Change | Expected Competitor Reaction | Demand Elasticity | Outcome for the Firm |
|---|---|---|---|
| Price Increase | Rivals do not follow | Elastic | Significant loss of customers and market share |
| Price Decrease | Rivals do follow | Inelastic | Minimal gain in customers; overall revenue might fall |
Implications of the Kink for Pricing Strategy
The kink in the demand curve leads to a discontinuity in the firm's marginal revenue (MR) curve. The MR curve has a vertical gap at the quantity corresponding to the kink. This gap means that the firm's marginal cost (MC) can fluctuate within a certain range without changing the profit-maximizing price and quantity. As long as the marginal cost curve intersects the discontinuous segment of the marginal revenue curve, the firm will find it optimal to maintain the current price and output level.
Practical Insights:
- Price Stability: The kinked demand model helps explain why prices in oligopolistic industries tend to be stable for extended periods, even when costs change. Firms are reluctant to initiate price changes due to the fear of losing market share or triggering a price war.
- Non-Price Competition: Because price adjustments are risky, firms in oligopolistic markets often resort to non-price competition, such as advertising, product differentiation, customer service, or innovation, to gain competitive advantage.
In essence, while the question refers to monopolistic competition, the "kink" is a defining characteristic of demand in an oligopoly, illustrating how strategic interdependence among a few dominant firms can lead to stable prices.
