Kinked demand hypothesis is designed to explain ________ in context of...
The oligopolist faces a kinked‐demand curve because of competition from other oligopolists in the market. If the oligopolist increases its price above the equilibrium price P, it is assumed that the other oligopolists in the market will not follow with price increases of their own.
Kinked demand hypothesis is designed to explain ________ in context of...
Explanation:
The kinked demand hypothesis is a theory of oligopoly pricing that explains price rigidity, which is the tendency of oligopoly firms to maintain stable prices despite changes in cost or demand. The hypothesis is based on the idea that the demand curve facing an oligopoly firm is kinked at the current price level, meaning that the demand is more elastic above the current price than below it. This leads to a situation where a firm will not change its price unless its costs change significantly or unless all of its competitors change their prices as well.
Price and Output Determination:
While the kinked demand hypothesis does have implications for price and output determination, it is primarily designed to explain price rigidity. The theory suggests that oligopoly firms will produce at a level where marginal cost equals marginal revenue, just like any other profit-maximizing firm. However, the kinked demand curve means that changes in costs or demand will not lead to changes in price or output unless they are significant enough to shift the entire demand curve.
Collusion between Firms:
The kinked demand hypothesis does not assume collusion between firms. Instead, it suggests that oligopoly firms will maintain stable prices and outputs even in the absence of collusion, due to the kinked demand curve.
Conclusion:
In conclusion, the kinked demand hypothesis is primarily designed to explain price rigidity in oligopoly markets. The theory suggests that oligopoly firms will maintain stable prices and outputs due to the kinked demand curve, even in the absence of collusion. While the theory does have implications for price and output determination, these are secondary to the main focus on price rigidity.