Page 213 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes 13.3 Kinked Demand Curve Models

There are two versions of the kinked demand curve model. One is called the Sweezy version
and the other is called the Hall and Hitch version. Both models were conceived independently
in 1939. The essential difference between these two versions is that Sweezy’s model is based
on the marginalist approach, with the hypothesis that even an oligopolistic firm aims at profi t

maximisation. In contrast, the Hall and Hitch version rejects the marginalist approach of profi t

maximisation. It argues that, under oligopoly, firms aim at ‘fair’ profit and follow the full cost
principle in determining the price.
13.3.1 Sweezy’s Model of Kinked Demand Curve

According to Sweezy, the most distinguishing feature of oligopoly is that an individual fi rm
does not know (and cannot determine) the exact nature (functional form) of its actual demand
curve because of the uncertainty and indeterminacy of rivals’ reactions to its own actions. An

oligopolistic firm is therefore guided in its decisions by the ‘imagined’ demand curve which is
based on what it expects to be the most likely (probable) reaction of its rivals.
Under oligopoly, a firm expects that when it raises its price, it is most likely that rival fi rms will

not follow suit by raising their prices. Instead, the rivals will keep their prices constant in order

to increase their sales at the expense of the firm that raises the price. Hence, when a fi rm increases
its price, its demand is expected to fall much more than it would if its rivals were not to keep their

prices constant. That is, for upward changes in price, a firm’s demand is expected to be highly
elastic.
In contrast, when the firm lowers its product price, it is most likely that its rivals will follow suit

because if they did not do so they would lose sales to the firm that lowered the price. Hence, when

a firm reduces its price, its demand is expected to increase much less than would otherwise have
been the case (because its rivals will also reduce their prices). That is, for downward changes in
the price, a firm’s demand curve is expected to be less elastic than it would have been had the

firm’s rivals not followed suit by reducing their prices.

Consequently, for an oligopolistic firm, the demand curve is highly elastic and gradually falling
for prices above the current or existing price, and for prices below the current price the demand
curve is less elastic and steeply falling.
!
Caution Because of the differences in elasticity (and slope) at prices above and below the

current price, the demand curve of the firm has a corner or a kink at the current or existing
price.

In Figure 13.5 the firm’s demand curve is APB, which has a kink or corner at current price
P and output ON. The upward segment AP is relatively more elastic than the downward segment
PB. That is, if e shows the elasticity of AP and e shows the elasticity of PB then e is > e . The
1 2 1 1 2
3 dotted line PB shows the decrease in the fi rm’s demand that would have occurred if the rivals
1

were not expected to keep their prices constant when the firm raised price above P. Dotted line
PA shows the rise in demand if rivals were expected not to follow any fall in price below P.
1

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