kinked demand curve under oligopoly
An oligopolist faces a downward sloping demand curve but the elasticity may depend on the reaction of rivals to changes in price and output. Assuming that firms are attempting to maintain a high level of profits and their market share it may be the case that:
(a) rivals will not follow a price increase by one firm - therefore demand will be relatively elastic and a rise in price would lead to a fall in the total revenue of the firm
(b) rivals are more likely to match a price fall by one firm to avoid a loss of market share. If this happens demand will be more inelastic and a fall in price will also lead to a fall in total revenue.
The kink in the demand curve at price P and output Q means that there is a discontinuity in the firm's marginal revenue curve.
If we assume that the marginal cost curve in is cutting the MR curve then the firm is maximising profits at this point.
In the bottom diagram, we see that a rise in marginal costs will not necessarily lead to higher prices providing that the new MC curve (MC2) cuts the MR curve at the same output. The kinked demand curve theory suggests that there will be price stickiness in these markets and that firms will rely more on non-price competition to boost sales, revenue and profits.
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