The kinked demand curve is a fundamental concept in microeconomics that has significant implications for market strategy and competitive analysis. First introduced by Paul Sweezy in 1939, this model describes a situation where a firm's demand curve has a kink or a discontinuity at the current market price. This occurs when a firm faces a competitive market, and its rivals will follow any price increase but not a price decrease. As a result, the firm's demand curve becomes more elastic above the kink and less elastic below it.
Understanding the Kinked Demand Curve Model
The kinked demand curve model is based on the assumption that firms in a competitive market will react differently to price changes depending on the direction of the change. When a firm increases its price, its rivals will follow suit to maintain their market share. However, if a firm decreases its price, its rivals will not follow, as this would lead to a loss of revenue for all firms in the market. This asymmetric response to price changes creates a kink in the demand curve, which has important implications for a firm’s pricing and output decisions.
Key Features of the Kinked Demand Curve
The kinked demand curve has several key features that distinguish it from other demand curves. Firstly, the curve is more elastic above the kink, meaning that a small price increase will lead to a large decrease in quantity demanded. Below the kink, the curve is less elastic, meaning that a small price decrease will lead to a small increase in quantity demanded. Secondly, the kinked demand curve is characterized by a discontinuity at the current market price, which creates a range of prices over which the firm’s demand curve is effectively flat.
| Price Range | Elasticity of Demand |
|---|---|
| Above the kink | High elasticity (Ed > 1) |
| Below the kink | Low elasticity (Ed < 1) |
| At the kink | Discontinuity in demand |
Implications of the Kinked Demand Curve for Market Strategy
The kinked demand curve has significant implications for a firm’s market strategy, particularly in terms of pricing and output decisions. Firstly, the model suggests that firms should be cautious when increasing prices, as this can lead to a large decrease in demand. Secondly, the model highlights the importance of considering the competitive response when making pricing decisions. Firms should be aware of their rivals’ likely response to a price change and adjust their strategy accordingly.
Competitive Analysis and the Kinked Demand Curve
The kinked demand curve model is closely related to competitive analysis, as it highlights the importance of considering the competitive response when making pricing decisions. Firms should analyze their rivals’ cost structures, market shares, and likely responses to price changes in order to inform their own pricing strategy. This can involve using tools such as game theory to model the competitive interaction between firms and predict the likely outcome of different pricing strategies.
- Conduct market research to understand rivals' cost structures and market shares
- Analyze rivals' likely responses to price changes using game theory
- Adjust pricing strategy to take into account the competitive response
Real-World Applications of the Kinked Demand Curve
The kinked demand curve model has a number of real-world applications, particularly in industries where firms face intense competition and are sensitive to price changes. For example, in the airline industry, firms are highly sensitive to price changes and will often follow each other’s price increases but not decreases. Similarly, in the retail industry, firms may use the kinked demand curve model to inform their pricing strategy and adjust to changes in the competitive landscape.
Case Study: The Airline Industry
In the airline industry, firms are highly sensitive to price changes and will often follow each other’s price increases but not decreases. This creates a kinked demand curve, where the curve is more elastic above the kink and less elastic below it. For example, if an airline increases its price, its rivals will follow suit to maintain their market share. However, if an airline decreases its price, its rivals will not follow, as this would lead to a loss of revenue for all firms in the market.
| Airline | Price Increase | Price Decrease |
|---|---|---|
| American Airlines | Rivals follow | Rivals do not follow |
| Delta Air Lines | Rivals follow | Rivals do not follow |
| United Airlines | Rivals follow | Rivals do not follow |
What is the kinked demand curve model?
+The kinked demand curve model is a microeconomic concept that describes a situation where a firm's demand curve has a kink or a discontinuity at the current market price. This occurs when a firm faces a competitive market, and its rivals will follow any price increase but not a price decrease.
What are the implications of the kinked demand curve for market strategy?
+The kinked demand curve has significant implications for a firm's market strategy, particularly in terms of pricing and output decisions. Firms should be cautious when increasing prices, as this can lead to a large decrease in demand, and should consider the competitive response when making pricing decisions.
In conclusion, the kinked demand curve model is a powerful tool for understanding the competitive dynamics of a market and informing a firm’s pricing strategy. By analyzing the kinked demand curve and considering the competitive response, firms can adjust their pricing strategy to maximize profits and maintain their market share. As the market landscape continues to evolve, the kinked demand curve model will remain an essential concept for firms seeking to navigate the complexities of competitive markets.
