Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

 
Check Your Progress: 
1. What do you understand by an oligopoly market?
2. Explain the characteristics of oligopoly. 
3. Give examples of oligopoly. 
4. Explain the significance of Cournot‘s model. 
 
1.3 KINKED DEMAND CURVE:
 
The concept of kinked demand curve was originally used to 
explain why, in an oligopoly market, the price which has been 
determined on the basis of average cost principle, would tend to 
remain rigid. The basic postulate of the average cost pricing is that 
the firm sets the price equal to the average total cost which 
includes not only average variable cost but also a gross profit 
margin. The yield is a normal profit. However, the kinked demand 

---

curve, used by Paul Sweezy, explained the observed rigidity of 
price in an oligopoly market. 
The kinked demand model is based on the following 
assumptions: 
• 
There are many firms in the oligopolistic industry. 
• 
Each producer manufactures a product which is a close 
substitute for that of the other firm. 
• 
Product qualities are constant, advertising expenditures are 
zero. 
• 
Each oligopolist believes that, if he reduces the price of his 
product, his competitors will also lower the prices of their 
products and that if he rises they will maintain the prices at 
the existing levels. 
Based on the above assumptions, the demand curve faced 
by any individual seller has a kink at the initial price-quantity 
combination. The kinked shape of the demand curve is based on 
the assumption that the competitors react differently to a rise in 
price or to a fall in price. It is also assumed that when an individual 
seller increases the price of his product other sellers will not 
increase their prices so that the sales of the seller increasing the 
price will be reduced considerably. This means that the demand 
curve is relatively elastic for a rise in price. On the other hand, it is 
assumed that when a single seller reduces the price, other sellers 
will also reduce the price so that the seller who reduces the price 
first cannot gain much for a fall in the price. Hence, when the price 
is reduced the demand curve will be relatively inelastic. The 
kinked demand curve is therefore based on the assumption that a 
rise in price by one seller will not be followed by the corresponding 
fall in the price by others and a reduction in price by a firm is 
followed by reduction in price by all other firms. This can be 
explained with the help of figure 1.2. 

---