Kinked demand curve model and Price Rigidity

The kinked demand curve model is a theory of oligopoly pricing that explains why firms in an oligopoly market tend to stick to their existing prices and avoid changing them. According to this model, the demand curve faced by an oligopolistic firm is kinked at the current price level, with a steep slope above that level and a flatter slope below it. The model explains the market situation of Price Rigidity.

Reasons for Price Rigidity

There are several reasons why oligopolistic firms may be reluctant to change their prices, including:

1. Fear of retaliation: If one firm raises its prices, its rivals may retaliate by cutting their prices, which could lead to a price war and lower profits for all firms.

2. Uncertainty about demand: Oligopolistic firms may be uncertain about how their customers will respond to a price change, which could lead to a loss of market share.

3. High fixed costs: Oligopolistic firms may have high fixed costs, which means that they need to maintain a certain level of revenue to cover their costs and make a profit.

4. Brand loyalty: Oligopolistic firms may have loyal customers who are willing to pay a premium for their products, which could limit the impact of price changes.

Conclusion

In conclusion, the kinked demand curve model explains the market situation of price rigidity in oligopoly markets. Oligopolistic firms in these markets may be reluctant to change their prices due to fear of retaliation, uncertainty about demand, high fixed costs, and brand loyalty. As a result, prices tend to remain stable in oligopoly markets, which can lead to higher profits for firms but may also limit consumer choice and innovation.