Transcript Kinked Demand Curve
Sweezy’s 1942 contribution. Samuelson immortalized it. The “young” oligopoly case. The industry starts out with price wars and gravitates toward “sticky prices.” There are two sets of demand curves: one where competitor’s respond to our initiative and one where they don’t. So we draw two sets of revenue curves. With the blue revenue curves, our competitors do respond. With the pink revenue curves, our competitors do not respond D2=AR MR2 We start with a price at the intersection of the blue and pink demand curves. To the left of that point (also Q), when we raise our price, we act alone – nobody follows our increase. When we reduce our price, competitors will follow and sales fall off rapidly. Not an appealing outcome! D1 Q MR1 We can simply erase the dotted segments of the respective revenue curves, since they are not relevant to the outcome. D1 Q MR1 To the left of Q, only D2 and MR2 are relevant, so erase D1+MR1 to the left of Q. To right of Q, only D1 and MR1 are relevant, so erase D2 and MR2 to the right of Q. D1 Q MR1 Sweezy observed: At the intersection of D1+D2 (the “kink”), we are in equilibrium. If we raise the price: Nobody follows us! If we reduce the price: everybody does! P D1 Q MR1 Note the discontinuous segment of the firm’s MR curve! The MR curve becomes vertical at Q, so that there is no incentive to change the output, Q, or the price as long as the MC curve intersects the MR at that output. P D1 Q MR1 MC P D1 Q MR1 Notice here that the MC cuts the MR at the discontinous segment of the MR curve MC Notice that this gold MC curve could be shifting up gradually without changing Q D1 or P. P Q MR1 MC P Observe! D1 Q MR1 MC P D1 Q MR1 Unfortunately, the model does not show us what causes a new equilibrium price and quantity to be achieved, and how that happens.