What Does a Point of Kink in the Demand Curve Indicate?
The point of kink in the demand curve, a defining characteristic of the kinked demand curve model primarily indicates both price rigidity and quantity rigidity within an oligopolistic market structure. This economic concept helps explain why prices in certain markets tend to be stable, even when costs or demand conditions might otherwise suggest a change.
Understanding the Kinked Demand Curve Model
The kinked demand curve model is a theoretical framework used to describe price and output determination in an oligopoly, a market structure characterized by a small number of large firms. Developed by Paul Sweezy, this model assumes that competing firms have an asymmetric response to price changes:
- Above the kink: If a firm raises its price, competitors are assumed not to follow, leading to a highly elastic demand curve (the firm loses significant market share).
- Below the kink: If a firm lowers its price, competitors are assumed to follow, leading to a relatively inelastic demand curve (the firm gains little market share, potentially triggering a price war).
The "kink" itself occurs at the prevailing market price and quantity, representing the point where the firm believes its competitors' reactions will change.
Price Rigidity
The most prominent indication of the kink in the demand curve is price rigidity. This means that prices in an oligopolistic market tend to be stable and resistant to change, either upwards or downwards.
- Reluctance to Increase Prices: Firms are hesitant to raise their prices above the kink because they anticipate that rivals will not follow suit. This would make their product relatively more expensive, leading to a substantial loss of customers and market share (due to the elastic demand segment).
- Reluctance to Decrease Prices: Firms are also hesitant to lower their prices below the kink. They expect that competitors will quickly match any price cuts to avoid losing their own market share. This leads to a price war where all firms' profits are eroded, and no firm gains a significant advantage (due to the inelastic demand segment).
This creates a strong incentive for firms to maintain the current price at the kink, as any deviation could lead to reduced profits.
Quantity Rigidity
Complementing price rigidity, the kink point also implies quantity rigidity. Because firms are incentivized to maintain the prevailing price, they also tend to maintain the corresponding output level.
- Stable Output: The output quantity at the kink represents a stable equilibrium where firms produce to meet demand at the rigid price. Significant changes in output would imply a change in price, which, as discussed, is generally avoided due to the expected reactions of competitors.
- Discontinuous Marginal Revenue: The kink in the demand curve leads to a vertical discontinuity in the marginal revenue (MR) curve. This means that if marginal costs fluctuate within this gap, firms will still find it optimal to produce the same quantity and charge the same price, further reinforcing both price and quantity stability. For more detailed insights into this, resources like Wikipedia's Kinked Demand Curve can be helpful.
Implications for Oligopolies
The concept of the kinked demand curve and the rigidities it implies has several important implications for firms operating in an oligopoly:
- Stable Market Prices: It helps explain why prices in industries like soft drinks, automobiles, or mobile phone services often remain stable for extended periods, even in the face of moderate changes in demand or cost.
- Non-Price Competition: Since price competition is often avoided due to the risk of price wars, oligopolistic firms frequently resort to non-price competition. This includes strategies such as:
- Advertising and branding: Building brand loyalty.
- Product differentiation: Offering unique features or designs.
- Customer service: Enhancing the customer experience.
- Promotions and special offers: Temporary incentives that don't alter the base price.
- Tacit Collusion: The model suggests a form of "tacit collusion," where firms implicitly agree not to engage in aggressive price competition, leading to more predictable market outcomes.
| Indication | Description |
|---|---|
| Price Rigidity | Prices tend to remain stable at the kink point, resisting upward or downward changes due to asymmetric competitor responses. |
| Quantity Rigidity | Output levels also tend to stabilize around the quantity corresponding to the kink, influenced by the stability of the price. |
