Kinked Demand Curve

Summary

In this video, the kinked demand curve, introduced by economist Paul Sweezy, is explained in detail. Unlike a regular demand curve, it has two segments: the elastic segment above the market price and the inelastic segment below it. The elastic segment reflects how a price increase by one firm leads to a significant drop in demand due to competition, while the inelastic segment shows how price reductions by firms only slightly increase demand. The video also discusses equilibrium in oligopoly markets and how price rigidity affects firms' pricing strategies. The kinked demand curve is a key concept for understanding market dynamics in oligopolistic industries.

Takeaways

• 😀 The Kinkra demand curve, proposed by economist Paul Suiji, is unique because it has two segments: an elastic segment above the market price and an inelastic segment below it.
• 😀 The Kinkra demand curve is represented with output on the x-axis and price on the y-axis, with two segments labeled AC (elastic) and CB (inelastic).
• 😀 The segment above the market price (AC) is highly elastic, meaning a small increase in price results in a large decrease in demand.
• 😀 When a firm increases its price slightly (e.g., 5%), the demand decreases significantly (e.g., 20%), showcasing the elastic nature of the AC segment.
• 😀 The reason behind the elasticity is that, in a market with multiple firms selling similar products, consumers can easily switch to competitors if one firm raises its price.
• 😀 The segment below the market price (CB) is inelastic, meaning a significant reduction in price leads to only a small increase in demand.
• 😀 For example, when a firm reduces its price by 20%, demand increases only by 2%, illustrating the inelastic nature of the CB segment.
• 😀 The inelastic demand in the CB segment occurs because if one firm reduces its price, competitors will also reduce their prices, limiting the overall increase in demand for the firm.
• 😀 Kinkra's demand curve highlights price rigidity in oligopolistic markets, where firms cannot easily adjust their prices without causing adverse effects.
• 😀 In equilibrium under Kinkra’s model, the marginal cost curve intersects the average revenue curve (which is the demand curve) at the equilibrium price and output, ensuring price and output stability as long as the marginal cost curve remains within the gap between the segments.

Q & A

What is the Kinked Demand Curve?

The Kinked Demand Curve is a concept in economics introduced by American economist Paul Sweezy. It differs from the standard demand curve as it has two distinct segments: an elastic segment above the market price and an inelastic segment below the market price.

Why is the segment above the market price considered highly elastic?

The segment above the market price is considered highly elastic because if a firm raises its price even slightly, its demand will drop significantly. This happens because consumers can easily switch to competitors offering similar products at lower prices.

What happens when a firm increases its price in a market with a kinked demand curve?

When a firm increases its price, the demand for its product will decrease substantially. As other firms keep their prices unchanged, consumers will prefer the lower-priced alternatives, resulting in a sharp reduction in the firm's sales.

Why is the segment below the market price considered inelastic?

The segment below the market price is considered inelastic because if a firm lowers its price, its demand will increase only slightly. This is because competitors will also lower their prices, reducing the impact of the price cut on the firm’s sales.

What does the kink in the demand curve represent?

The kink in the demand curve represents the point where the price and quantity are relatively stable. The curve has a steep slope above the kink (elastic) and a flatter slope below it (inelastic), indicating that firms are unlikely to change prices drastically in either direction.

How does price rigidity affect firms in an oligopoly market?

Price rigidity in an oligopoly market means firms are hesitant to change their prices. If one firm raises its price, others will not follow, leading to a loss of demand for the firm that increased its price. If one firm reduces its price, competitors will follow suit, minimizing the gain in demand for the price-reducing firm.

What is the relationship between the kinked demand curve and marginal revenue?

In the kinked demand curve model, the marginal revenue (MR) curve is also divided into two segments. The MR curve mirrors the kinked nature of the demand curve, with a vertical gap at the kink point, reflecting the price and output stability despite fluctuations in demand.

What happens when the marginal cost curve intersects the marginal revenue curve in the kinked demand model?

The equilibrium price and quantity occur when the marginal cost curve intersects the marginal revenue curve. As long as the marginal cost curve passes through the vertical gap between the two segments of marginal revenue, the price and output will remain unchanged.

Why does a firm’s demand increase only slightly when it reduces its price in the inelastic segment?

A firm’s demand increases only slightly when it reduces its price in the inelastic segment because other competing firms will also lower their prices. As a result, the price reduction has minimal impact on the firm's total demand.

How does the kinked demand curve model explain the behavior of firms in an oligopolistic market?

The kinked demand curve model explains that firms in an oligopoly are reluctant to change prices due to the risk of losing market share if they raise prices or not gaining much by lowering them. This leads to price stability in the market, with firms preferring to compete on non-price factors instead.