Answer to Question #180417 in Microeconomics for Darshana

Question

Illustrate a kinked demand curve and discuss why the demand curve has a kink under Oligopoly. Also explain the discontinuity in the shape of the resulting marginal revenue curve. On what does the extent of this discontinuity depends? 

Answer 1

 

A kinked demand curve occurs when the demand curve is not a straight line and has different elasticities for lower and higher prices. The demand curve has a kink under Oligopoly because of the competition it faces from other oligopolies in the market. If the Oligopoly raises its prices above equilibrium, it is assumed that the other oligopolies will not raise their prices. The MR curve is discontinuous at the level of output corresponding to the kink. The discontinuity implies there is a range within which cost may change without affecting equilibrium price and quantity. The extent of this discontinuity depends on the elasticities of the upper and lower parts of the kinked demand curve. The discontinuity enlarges as the elasticities of lower and upper parts of the kinked demand curve become greater.