“Kinked" demand curves are similar to traditional demand
curves, as they are downwardsloping. They are distinguished by a hypothesized
convex bend with a discontinuity at the bend– "kink". Thus the first
derivative at that point is undefined and leads to a jump discontinuity in the marginal
revenue curve.
Classical economic theory assumes that a profit-maximizing
producer with some market power (either due to oligopoly or monopolistic
competition) will set marginal costs equal to marginal revenue. This idea can
be envisioned graphically by the intersection of an upward-sloping marginal
cost curve and a downward-sloping marginal revenue curve (because the more one sells,
the lower the price must be, so the less a producer earns per unit). In
classical theory, any change in the marginal cost structure (how much it costs
to make each additional unit) or the marginal revenue structure (how much
people will pay for each additional unit) will be immediately reflected in a
new price and/or quantity sold of the item. This result does not occur if a
"kink" exists. Because of this jump discontinuity in the marginal revenue
curve, marginal costs could change without necessarily changing the price or
quantity.
The motivation behind this kink is the idea that in an
oligopolistic or monopolistically competitive market, firms will not raise
their prices because even a small price increase will lose many customers. This
is because competitors will generally ignore price increases, with the hope of
gaining a larger market share as a result of now having comparatively lower
prices. However, even a large price decrease will gain only a few customers
because such an action will begin a price war with other firms. The curve is
therefore more price-elastic for price increases and less so for price
decreases. Firms will often enter the industry in the long run.
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