|Price rigidity in the oligopoly market is best explained by the kinked demand curve. |
The oligopoly is a reduced form of monopolistic competition. The term oligopoly has a Greek base and means few sellers, oligopoly as such, refers to markets with small number of large firms, each selling either differentiated or homogeneous product. A few sellers imply a number
- Sellers are few in number.
- Any of them is of such a size that an increase and decrease in his output will appreciably affect the market price. In fact, the size of each seller’s output in relation to the total supply is the test.
- Each seller knows his competitors individually in each market.
It is the fewness of sellers that introduces interactions into the price and output decision problem under oligopoly a special form of oligopoly in duopoly, under which only two firms produce a particular product.
Kinked Demand Curve ModelThe kinked demand curve model developed by Paul M. Sweezy, has features common to most of oligopoly pricing models. The kinked demand curve analysis does not deal with price and output determination. It seeks to establish that once a price-quantity combination is determined, an oligopoly firm will not find it profitable to change its price in response to a moderate change in cost of production. An oligopoly form believes that if it reduces the price of its product, rival firms would follow and neutralize the expected gain from price reduction. But, if it raises its price, rival firms would either maintain their prices or may even cut their price down. In either case, the price rising firm stands to lose, at least a part of its share in the market. This behavioral assumption is made by all the firms in respect of others. The oligopoly firms would therefore, find it more desirable to maintain their price and output at the existing level.
There are three possible ways in which rival firms may react:
- The rival firms follow the price changes, both cut and hike;
- The rival firms do not follow the price changes;
- Rival firms do not react to price-hikes but they do follow the price-cuts.
According to the kinked demand curve model firm determines the price and output by intersection of MC and MR. But intersecting point lies on the discontinuous segment of MR. In this model, the demand curve faced by oligopolists has kink at the prevailing price. It means, the upper section of the kinked demand curve has higher price elasticity than lower part. Because, each oligopolist believes that if he reduces his price below the prevailing level, his competitors will follow him, and will accordingly lower their prices. So that an oligopolist firm which lowers the price could not increase its share of the market. Whereas if he raises the price above the prevailing level, his competitors will not follow him and they do not increase their price. So, an oligopolist will lose a considerable part of his customers. Because of this, an oligopolist tends to keep prices constant even if the cost and demand conditions are changed. This model is illustrated in figure.
We may conclude that an oligopolist faced with a kinked demand curve will be extremely unwilling to change his price. For a fall in his price will cause no large increase in his sales whereas a price increases will cause a substantial decline in his sales. Thus, neither a price increase nor a price reduction will be an attractive proposition for the oligopolist. During inflationary periods, however, oligopoly firms often follow one another’s price increase, to this extent, the kinked demand curve analysis can be said not to hold true.