The kinked demand curve is an economic theory that explains why prices in some markets—especially oligopolies—tend to remain stable even when economic conditions kinked demand curve. It focuses on how firms anticipate competitor reactions when deciding whether to raise or lower prices.
Kinked Demand Curve
In simple terms, it explains why companies often “stick” to the same price for long periods.
Basic Idea of the Kinked Demand Curve
The model is based on a key assumption about how competitors behave:
- If a firm raises its price, competitors will not follow, causing the firm to lose many customers.
- If a firm lowers its price, competitors will match the cut, so it gains very little extra market share.
Because both actions are risky, firms avoid changing prices.
Why It Is Called “Kinked”
The demand curve has a sharp bend at the current market price, known as the kink.
- Above the current price: demand is highly elastic (customers quickly switch away if prices rise).
- Below the current price: demand is less elastic (competitors match price cuts).
This change in elasticity creates a broken or “kinked” shape in the curve.
The Result: Price Rigidity
One of the most important outcomes of this theory is price stability.
Even when:
- production costs increase or decrease
- demand shifts in the market
- external economic conditions change
firms often keep prices unchanged because any change may reduce profits.
Real-World Example: Supermarket Fuel Prices
Imagine several fuel stations in one area:
- If one station increases prices, customers move to cheaper stations.
- If one station lowers prices, others immediately match it.
As a result, prices remain nearly identical for long periods, even if costs fluctuate.
Key Assumptions
The kinked demand curve model relies on several assumptions:
- The market is an oligopoly with a few large firms
- Firms closely monitor competitor pricing
- Competitors react differently to price increases and decreases
- Firms prefer stable prices over risky competition
Limitations of the Model
Although useful, the theory has weaknesses:
- It does not explain how the initial price is set
- It ignores collusion or price agreements
- It may not fit highly dynamic or innovative industries
- It is difficult to test accurately in real markets
Conclusion
The kinked demand curve explains why prices in oligopolistic markets often remain stable despite changes in costs or demand. It shows how uncertainty about competitor reactions leads firms to avoid price changes, resulting in long periods of price rigidity.