Answer to Question #242654 in Economics of Enterprise for John

Question

With the aid of a diagram, explain the economic theory underlying a kinked demand curve. Justify whether it would be applicable in this case

Answer 1

According to kinked-demand theory each firm faces two demand curves for its product.

At high prices the firm will experience elastic market demand curve. At low prices the firm will face an inelastic demand curve.

The following figure has a kinked demand curve dD with a kink at point P.

From the diagram:

1.Price level$=$ P

2.Firm produce and output$=$ OM

3.Upper segment of dP of the demand curve is elastic

4.Lower segment of PD of demand curve dD is relatively inelastic.