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Kinked demand curve as one model to describe interdependent behaviour

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Kinded-demand-curve


The kinked demand curve can be illustrated as the aforementioned outcome of price rigidity in non-collusive oligopoly. In these terms, kinked means "bent". The prisoner’s dilemma is an example of a highly interdependent situation, where a change in price will certainly lead to reaction from other firms in the oligopoly. The diagram suggests what a firm will do.

=> If there is a higher price setting, it will cause a relatively large loss of market share and therefore the demand curve will be elastic above the starting equilibrium price of PEQ. Then the firm would lose sales to other firms by raising their prices.

=> If there is a lower price setting, than a firm would quickly be followed by competitors who themselves would fear losing sales to the price-lowering firm. Therefore any decrease in price below PEQ would mean a more inelastic demand curve.

The demand curve will be “kinked” at the point of equilibrium price and output, as the MR curve is dependent on the shape of the demand curve than there is a “blank” space at QEQ , where the MR curve is discontinued.

This kinked demand curve allows there to be a range of MC curves for which the firm will be a profit maximizer. If the MC curve hits the MR curve anywhere along the vertical part of the MR curve that is due to the kinked demand curve, then the firm will be profit maximizing.

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