Published Apr 29, 2024 ### Definition of Kinked Demand Curve A kinked demand curve is a graphical representation used in economic theory to describe a market situation where a product’s price elasticity changes abruptly at a certain point. This concept is primarily associated with oligopolistic markets, where a small number of firms dominate and each firm’s pricing decisions are closely dependent on the actions of its competitors. The curve is characterized by a distinct “kink” at the current market price, illustrating how firms may respond differently to price increases versus price decreases. ### Example Consider an oligopolistic market for home internet services, dominated by two major companies: NetFast and WebSpeed. Initially, both companies charge the same price for similar high-speed internet services. According to the kinked demand curve theory, if NetFast decides to increase its price, it is unlikely that WebSpeed will follow. Since consumers see the services as substitutable, a price increase by NetFast would lead to a significant loss of customers to WebSpeed, who did not raise their prices. Therefore, the demand for NetFast’s service becomes highly elastic for price increases—customers are sensitive to price changes and would rapidly decrease their demand in response to the hike. Conversely, if NetFast lowers its prices, WebSpeed is likely to match the price reduction to avoid losing customers. In this scenario, the demand for NetFast’s services becomes inelastic to price decreases, meaning that while NetFast might gain some of WebSpeed’s customers, the overall increase in quantity demanded for its services does not proportionally match the price cut, partly because the action is mirrored by WebSpeed. This asymmetrical consumer response creates a kink in the demand curve at the current price level. ### Why the Kinked Demand Curve Matters The kinked demand curve model helps explain why prices in oligopolistic markets may be rigid or sticky, meaning they don’t change frequently. Firms within these markets are wary of changing prices since the expected reactions from competitors either lead to a significant loss of market share (if prices are raised) or minimal gain with reduced profit margins (if prices are cut). As a result, prices tend to remain stable over time, despite shifts in production costs or broader economic trends. The kinked demand curve highlights the strategic interdependence of firms in oligopoly and how their pricing strategies are contingent upon expectations of competitors’ reactions. ### Frequently Asked Questions (FAQ) #### What are the implications of a kinked demand curve for market competition? The kinked demand curve implies a high degree of market stability in terms of pricing, with firms being hesitant to change prices for fear of unfavorable responses from competitors. This can result in less competitive behavior in terms of pricing, potentially leading to higher profits for the firms but higher prices for consumers compared to more competitive markets. #### Is the kinked demand curve applicable to all market structures? No, the kinked demand curve concept is specifically associated with oligopolistic markets, where a few firms have significant control over the market. It does not apply to perfect competition, where many firms sell homogeneous products and no single firm can influence market prices, nor does it apply to monopoly, where only one firm controls the entire market. #### How do firms in an oligopoly determine their pricing strategies with a kinked demand curve? Firms operating under conditions described by the kinked demand curve model often rely on a mix of strategic considerations, market research, and psychological insight into their competitors’ potential responses to price changes. Understanding market dynamics, cost structures, and consumer preferences plays a crucial role in shaping these strategies. Additionally, non-price competition becomes more significant, with firms seeking to differentiate their products through quality improvements, branding, and customer service enhancements to gain market share without altering prices.
Economics