Answer to Question #260189 in Macroeconomics for emu

Question

“Neither empirical evidence nor theoretical logic offers any justification for the persistence of the dominant position of the kinked demand curve as a model of oligopolistic behavior.” Discuss this statement and consider whether alternative models of oligopoly represent any advance on the kinked demand model.

Answer 1

The kinked demand curve theory of oligopoly seeks to expaund on the rigidity of prices under oligopolistic market. It is argued that given an existing price in an oligopolistic market,if a single firm inclines its price, the rivals of the firm do not respond. However, if the firm declines its price, other rival firms will cut down their prices too.

This clearly explains the reason as to why an individual firm will have a kink at the existing price level and the consequence of this is, the price won't change for small changes in cost and demand.

Emperical evidence remains fixed about this situation, and the model of kinked demand is criticized on theoritical ground majorly due to its arbitrariness in regard to both the existing price and the response of the firms.

This critism has been addressed through the provision of equilibrium foundation to the theory in question. Through the consideration of price competition in duopoly, it is shown that under equilibrium, both firms will charge a sufficiently high common price and this collusive outcome is sustainable by the use of kinked demand strategy.

Neither of these theories predict price rigidity. This is the phenomena that the original theory of kinked demand seeks to elaborate.