Question
In the Sweezy Model of Oligopoly, the Kinked Demand
Curve is used to explain why prices in oligopolistic markets remain relatively stable (Price Rigidity). What is the conceptual reason for the kink in the firm's demand curve?Solution
If a firm raises its price, competitors will not follow (to gain market share), making the firm's demand highly elastic (it loses many customers). If the firm lowers its price, competitors will follow (to prevent losing customers), making the demand inelastic (it gains very few new customers). This shift in elasticity at the current price level creates a "kink." Because of this kink, the Marginal Revenue (MR) curve has a vertical gap (discontinuity). As long as the Marginal Cost (MC) stays within this gap, the firm will not change its price, leading to price rigidity.
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