Kinked Demand Curve

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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.