What are the Positive and Negative aspect of Kinked demand curve model theory of oligopoly?

Question

The kinked demand theory of oligopoly is the assumption of rivals are likely of matching a price increase not decrease, the oligopoly believe in the theory that they face a downward sloping demand curve which is kinked at the current price, what i wanted to know is what are the positive and negative aspect of the kinked demand curve? Why does oligopolists have to start at the equilibriun price and output even if the profit maximization can be reach at the equilibrium P&Q.

Answer 1

There are no positive and negative aspects. Kinked demand curve is a theory, not a fact. It explains very well why prices in oligopolistic industries tend to be stable and why price decreases by one oligopolist are usually matched by others, while price increases are usually not. It does not, however, explain how an industry becomes an oligopoly...

Answer 2

Positive aspect -- the company with the lower price will probably sell more -- negative aspect it can create a monopoly by one company being able to afford to take a loss on a product for a longer amount of time. If I understand this right. Beneath is some info on found on the concept of the Kinked Demand curve.

The Kinked Demand Curve

In an oligopolistic setting, firms have two possible strategies in response to any price change by their rivals--they may either match the price change or they may ignore it. Let P = f(Q) be the demand curve corresponding to a "match-price strategy" and P = g(Q) be the demand curve corresponding to an "ignore-price strategy." Both demand curves are downward sloping, however f(Q) is steeper than g(Q): f ’(Q) > g’(Q). (P = f(Q) is shown by demand curve "D1" in your text while P = g(Q) is shown by demand curve "D2.") The "kinked" demand curve model assumes a combined strategy by firms in an oligopoly: match a price decrease but ignore a price increase by one’s rivals. If all firms follow such a strategy, then the demand curve facing each firm will have a "kink" in it at the going price. That is, demand is given by P = f(Q) for prices below the going price, by P = g(Q) for prices above the going price.

The firm’s revenue after a price decrease is R1(Q1) = Qf(Q1) and marginal revenue is R1’(Q1) = f(Q1) + Q1f ’(Q1) = P(1 - 1/E1) where E1 is the elasticity of demand along the demand curve P = f(Q) at Q1. (This correspondence between marginal revenue and the elasticity of demand was illustrated in the previous math note.) However, the firm’s revenue after a price increase is R2(Q2) = Q2g(Q2) and marginal revenue is R2’(Q2) = g(Q2) + Q2g’(Q2) = P(1 - 1/E2) where E2 is the elasticity of demand along the demand curve P = g(Q) at Q2. At the going price, Q1 = Q2 and E1 < E2. Substituting these relationships into the corresponding relationships for marginal revenue, it is clear that MR1 = P(1 - 1/E1) < P(1 - 1/E2) = MR2. That is, the firm’s marginal revenue for a price decrease is less than the marginal revenue for a price increase; the marginal revenue function must have a "gap" at the going price.

Answer 3

Positive: Stack it high sell it cheap.
The main aim is to maintain market share.

An oligopolist faces a downward sloping demand curve but the elasticity may depend on the reaction of rivals to changes in price and output. Assuming that firms are attempting to maintain a high level of profits and their market share it may be the case that:
(a) rivals will not follow a price increase by one firm - therefore demand will be relatively elastic and a rise in price would lead to a fall in the total revenue of the firm
(b) rivals are more likely to match a price fall by one firm to avoid a loss of market share. If this happens demand will be more inelastic and a fall in price will also lead to a fall in total revenue.

Answer 4

Shouldn't it increase? An Oligopolistic market has many competitors, if one firm lowers it's price, it's product becomes more attractive relative to other products in the same market and therefore demand for it will increase, generating greater revenue that covers the loss in revenue from the decrease in price.

Answer 5

Sell as much as you can as cheaply as you can for as long as you can. Grab an extra slice of the market whilst you can, and then do your best to hold it, whilst the competition are still working out what to do. The revenue lost in this`plan` will be made up by a price rise when delivering the next consignment of goods. This rise will have also applied to the competition, so even if they follow through the rise, they will still have lost out in terms of total sales and profit.