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Kinked Demand
One early model held that oligopolies face kinked residual demand curves (Hall and Hitch
1939; Sweezy 1939). In Sweezy's version, an oligopolist believes its rivals quickly match price
reductions but follow price increases only slowly and incompletely. [This model can be
presented as a best response by a firm to a rival's strategy of "match price reductions but
ignore price increases."] Each firm faces a demand curve that is more elastic above a
price, p*, than it is below that price, as shown in Figure.
Figure Kinked Demand Curve Model
If firms face such demand curves, the price, p*, is profit maximizing for any marginal cost
curve (MC) that cuts the vertical section of the marginal revenue curve (MR). For
example, p* is the profit-maximizing price for both MC1 and MC2 in Figure. The kinked demand
theory of oligopoly behavior predicts that prices are likely to remain unchanged for small
changes in costs.
Unfortunately, this theory is silent on how price is initially set and, hence, does not explain
price levels. At best, it explains why price does not change in response to moderate shifts in
cost. In response to large shifts in cost, the theory predicts that price should change, although
it provides no guidelines as to how the new price level is set.
Stigler (1947) found no empirical evidence of asymmetry in the reaction of oligopolists to price
changes by rivals. Moreover, the theory predicts that there will be no kink (the prices become
more flexible) when the oligopolists collude. Stigler's evidence contradicted this hypothesis
too. Finally, the theory predicts that large shifts in costs cause prices to change whereas small
shifts do not. Stigler also rejected this prediction. As a result, the original kinked demand
theory is largely discredited. Some recent models determine the price level and have the
property that residual demand curves have kinks (Salop 1979, Schmalensee 1982, Chapter 8).
SOURCES: Bowley, Arthur L. 1924. The Mathematical Groundwork of Economics. Oxford: Oxford University
Press. Hall, R.L. and C.J. Hitch. 1939. "Price Theory and Business Behavior." Oxford Economic
Papers 2:12-45. Salop, Steve C. 1979. "Monopolistic Competition with Outside Goods." Bell Journal of
Economics 10:141-56. Schmalensee, Richard. 1982. "Product Differentiation Advantages of Pioneering
Brands." American Economic Review 72:349-65. Stigler, George J. 1947. "The Kinky Oligopoly Demand
Curve and Rigid Prices." Journal of Political Economy. 55:432-49. Sweezy, Paul M. 1939. "Demand Under
Conditions of Oligopoly." Journal of Political Economy 47:568-73.