Answer to Question #310493 in Economics of Enterprise for rori

Question

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

Answer 1

This model is based on the assumption that prices in the market are unchanged (fixed prices), and that oligopolists operate in the market on their own, independently of each other (non-cooperative oligopoly).This model explains the fact that in an oligopoly, when there is no collusion between oligopolistic firms, changes in output volumes can occur without changing prices.

Price stability can be explained if individual firms believe that rivals will not follow any increase in their price. At the same time, they believe that their rivals will follow their price cuts.

DD is the demand curve for the case when all firms charge the same price. Starting from point K, if one of the firms charges a higher price than its rivals, it will give up part of its sales to its rivals, so its demand curve is limited to DnK. If this firm charges a lower price than its competitors, it will not be able to capture market share from them, because competitors will also lower prices in accordance with the DD curve to prevent this. Thus, it is obvious that price increases and decreases cancel themselves out. A break in the demand curve corresponds to a break in the marginal revenue curve. This means that when the marginal cost curve shifts within the XY segment, the price at point K will remain the profit-maximizing price.