How Does the Kinked Demand Curve Explain Oligopoly Pricing?
Learn how rival responses create a kinked demand curve, why a gap in marginal revenue can keep oligopoly prices stable, and what the model cannot explain.
The kinked demand curve explains why an oligopoly firm may keep its price unchanged even when its costs change. It assumes that rival firms match a price cut but do not match a price rise.
A Level focus: This answer covers the relationship between price elasticity of demand and a firm’s revenue for both a normal downward-sloping demand curve and a kinked demand curve, the two parts of syllabus point 7.8.5.
Why is there a kink?
An oligopoly is a market dominated by a few firms, so each firm considers how its rivals might respond. Suppose a firm is charging price P0P_0P0. If it raises its price and rivals leave theirs unchanged, many customers switch away. Demand above P0P_0P0 is therefore relatively elastic: quantity demanded responds strongly to the price change.
If the firm cuts its price and rivals match the cut, it gains few extra customers. Demand below P0P_0P0 is relatively inelastic: quantity demanded responds less strongly. These two sections meet at a kink.
Why might the price stay the same?
On a normal downward-sloping demand curve, the effect of a price change on total revenue depends on elasticity: a price rise reduces total revenue where demand is elastic, while a price cut reduces it where demand is inelastic. The kinked model puts those two unattractive outcomes on opposite sides of the current price.
The kink also creates a gap in the marginal revenue curve. Marginal revenue is the extra revenue from selling one more unit. If marginal cost changes but still crosses that gap, the firm’s profit-maximising output and price can remain unchanged.
Exam mistake to avoid: the model offers a reason for price stability; it does not explain how the original price was set or prove that oligopoly prices never change.
