Assume that there are two organizations that have formed a cartel. As a result, demand curve facing a firm under differentiated oligopoly is not perfectly elastic. It is tempting to increase output and sell as much of it as you can at the higher price before everyone else cottons on. Usually, the first firm who confesses to the regulator is protected from prosecution, so there is always an incentive to be the first to confess. Sweezy on the one hand and Profs.
Product that appeals , Price difficult to vary significantly , Promotion advertising, marketing, etc. Pepsi would unlikely gain any more market share while the lower market price of soft drinks might increase quantity demanded in the overall market. This makes advertising and the quality of the product are often important. Moreover, the profits would remain same between point X and Y. This enables the industry to become more profitable.
They monitor each other's actions closely because any action by one firm will directly affect the others. Analysis of the Kinked Demand Curve Model : In the oligopoly model under discussion, the properties of the kinked demand curve as well as its significance are especially discussed. Why the Kink in the Demand Curve? See: Collusion and game theory Game theory is looking at the decisions of firms based on the uncertainty of how other firms will react. Thus, there is no motivation for increasing or decreasing prices. In the event of increase in demand, an oligopolist can expect that if he initiates the increase in price, his competitors will most probably follow him. But they are expected to follow price rises only slowly and partially since they are eager to increase their market share.
Provides opportunities to prevent the entry of new organizations The agreement of collusion formed may be tacit or formal in nature. When price leadership and price cartels exist in oligopolistic markets there is concerted behaviour in regard to the price changes and hence there is no kink in the demand curve in these cases. The oligopolist who raises his price will be able to retain only those customers who either have a strong preference for his product if the products are differentiated or who cannot obtain the desired quantity of the product from the competitors because of their limited productive capacity. The demand segment corresponding to lower prices is less elastic than the demand segment corresponding to higher prices. All family saloon cars are similar today, but which ones have air-conditioning fitted as standard? Thus, the rivals would gain control over the market.
Assuming that overall demand is unlikely to rise substantially, all three firms will find that the rise in demand for their petrol is proportionately small compared with the proportionate fall in price, so their revenues fall. What emerges is a kinked demand curve, highly elastic at prices above the current equilibrium and highly inelastic at prices below the current equilibrium. This maximises profit for the industry. The Kinked Demand Curve Model: The idea that administered prices are flexible upward and not downward is supported by a theoretical analysis of the situation faced by the oligopolistic firm. Some of the major points of criticism are as follows: i. So they will have a tendency not to change the price at all.
It is important to bear in mind, there are different possible ways that firms in Oligopoly can behave. The goal of a cartel is for the few firms in the industry to join together and, effectively, form a monopoly. The firm will be worse off. This demand curve is relatively flat above A and relatively steep below A. This indicates that the price will remain unchanged in the case of decrease in demand. This model should explain why.
Unfortunately, there is a lot of uncertainty in oligopoly. Thus, unless there is a substantial shift of the demand or cost curve, the equilibrium output-price combination i. This would result in producing the kinked demand curve. Since the oligopolist will not gain a large share of the market by reducing his price below the prevailing level, and will have substantial reduction in sales by increasing his price above the prevailing level, he will be extremely reluctant to change the prevailing price. Summary We explained the kinked demand curve model of oligopoly. Price wars There is not much to say here. If the oligopolist increases its price above the equilibrium price P, it is assumed that the other oligopolists in the market will not follow with price increases of their own.
This indicates that the firm will maximise its profit by producing 9,000 units at the industry-wide price of Rs 10. This means getting together and making an agreement about quantities produced and, therefore, prices. The price is reduced to below cost price, a definite loss leader, so that the competitor cannot cope. This is because, as the firm reduces or increases the price of its product, the prices of the products of other firms remaining constant, the product of the firm becomes relatively cheaper or dearer, respectively, than those of the other firms. It is an attempt by the firms in an oligopolistic situation to eliminate any competition, which is bad for the consumer.
In other words, how does one arrive at the initial price and quantity? Because of this kinked shape, the profit maximizing level of output is exactly at the kink. Firms with established brands can easily charge a premium on their products. Now, this output will be allocated among the organizations. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve. Assumptions of the Kinked Demand Curve Model 2. The other two firms know this is going to happen following the price cut, so they match the price cut see price wars later. Criticisms of the Kinked Demand Curve Model: There are two main criticisms of the kinked demand curve model.
But increases would not be matched, and the firm trying to raise its prices would lose. Competition in the Aluminium Industry: 1945-58. An Economist Among Mandarins: A biography of Robert Hall 1901-1988. The model is presented below. The kinked demand curve hypothesis was put forward independently by Paul M. When there is a rise in cost of industry an oligopolist can reasonably expect that his increase in price will be followed by the others in the industry. Variable Market Share If the price and market share both changed and competitors did not match the price change, buyers would switch to other soft drinks.