Kinked Demand Curve
What is Kinked Demand Curve?
The kinked demand curve is an oligopoly model where rivals match price cuts but ignore price hikes, creating a kink at the current price and sticky (rigid) prices.
Each firm assumes that if it raises its price, competitors will not follow, so it loses many customers (demand is elastic above the kink); but if it cuts price, rivals match to protect their share, so it gains few customers (demand is inelastic below the kink). This kink produces a vertical gap in the marginal revenue curve, meaning marginal cost can shift within that gap without changing the profit-maximizing price or quantity, explaining why oligopoly prices tend to be rigid. The model describes price stickiness but does not explain how the original price is set.
Kinked Demand Curve: a worked example
Northline Airways sells 500 seats a week at $200 on one route. Above the kink demand is P = 250 - 0.1Q, so lifting the fare to $220 leaves only 300 seats sold, a 40 percent volume loss for a 10 percent price rise, an elasticity of 4.0. Below the kink rivals match, so demand is P = 350 - 0.3Q and cutting to $170 lifts sales only to 600, a 20 percent gain for a 15 percent cut, an elasticity of 1.33. Marginal revenue on the upper branch at Q = 500 is 250 - 0.2(500) = $150; on the lower branch it is 350 - 0.6(500) = $50. Any marginal cost between $50 and $150 leaves the fare at $200.
The mistake students make with kinked demand curve
The branches get flipped constantly. Demand is highly elastic above the current price, because a lone price rise sends buyers to rivals who held steady, and far less elastic below it, because rivals match a cut so almost nobody switches to you. Students reverse this by reasoning that price cuts always win customers. A second slip is treating the model as a theory of pricing; it explains why a price stays put once chosen, not how the firm picked $200 to begin with.
Kinked Demand Curve questions
Why is the demand curve kinked in an oligopoly?
The kinked demand curve comes from one assumption about rivals: they copy price cuts but ignore price rises. That asymmetry gives a single firm two different demand curves joined at the current price, a flat and highly elastic branch above it and a steep, far less elastic branch below. The kink sits at whatever price the industry happens to be charging, so it relocates if the industry price relocates.
What does the gap in the marginal revenue curve mean?
The gap in the marginal revenue curve is the vertical jump where the two demand branches meet, and it is the reason oligopoly prices look sticky. Marginal cost can drift anywhere inside that gap and still cross marginal revenue at the same quantity, so the firm has no reason to move. Only a cost change large enough to escape the gap forces a new price.
What is the main criticism of the kinked demand curve model?
The kinked demand curve model is criticized for assuming the rival reaction rather than deriving it, and for having nothing to say about where the starting price came from. It begins with a price, explains why that price holds, then stops. Game-theoretic models of oligopoly, which work out each firm's best response from the payoffs, account for both the level of price and its stability.
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