The kinked demand curve is an economic model that explains why prices in certain markets—especially oligopolies—tend to remain stable even when market conditions kinked demand curve. It focuses on how firms react to each other’s pricing decisions and how this interdependence affects pricing behavior.
Kinked Demand Curve
In simple terms, it shows why companies often avoid changing prices even when they might want to.
The Core Idea
The model assumes that firms in an oligopoly believe their competitors will react differently depending on price changes:
- If a firm raises prices, competitors will not follow, causing the firm to lose many customers.
- If a firm lowers prices, competitors will match the cut, preventing it from gaining much market share.
Because both outcomes are unfavorable, firms prefer to keep prices unchanged.
Why It Is Called a “Kinked” Curve
The demand curve is “kinked” because it has two different slopes at the current market price:
- Above the current price: demand is very elastic (customers quickly leave if price rises)
- Below the current price: demand is less elastic (competitors match price cuts)
This creates a sharp bend—or “kink”—at the prevailing price level.
Price Rigidity in the Market
A key implication of the kinked demand curve is price rigidity. This means prices stay stable even when:
- production costs increase or decrease
- demand shifts in the market
- external economic conditions change
Firms avoid changing prices because any change could reduce profits due to competitor reactions.
Example: Airline Industry
Consider several airlines operating on the same route:
- If one airline raises ticket prices, passengers switch to cheaper competitors.
- If one airline lowers prices, others immediately match the reduction.
As a result, ticket prices often remain stable for long periods, even when fuel costs fluctuate.
Key Assumptions of the Model
The kinked demand curve is based on several assumptions:
- Few firms dominate the market (oligopoly)
- Firms closely observe competitors’ pricing
- Price changes trigger strong reactions from rivals
- Firms prefer stability over risky price competition
Limitations of the Theory
Although widely taught, the model has some limitations:
- It does not explain how the original price level is set
- It ignores cooperation or collusion among firms
- It may not apply to highly dynamic or innovative markets
- It is difficult to test empirically in real industries
Conclusion
The kinked demand curve provides a useful explanation for why prices in oligopolistic markets often remain unchanged over time. It highlights the importance of competitor reactions in shaping pricing decisions and shows how interdependence among firms leads to stable but rigid market prices.