A kinked demand curve is a graphical representation of a firm's price-quantity relationship in which the curve has a "kink" or a break at a specific price point. This phenomenon occurs when a firm faces a price increase and a price decrease in different parts of the curve. The kinked demand curve model was developed by economists Richard Lipsey and Kelvin Lancaster in the 1950s as a way to explain why firms sometimes choose not to lower their prices in response to a decrease in market demand.
One of the key features of a kinked demand curve is the presence of two different elasticities of demand: a relatively elastic section on one side of the kink, and a relatively inelastic section on the other side. The elasticity of demand refers to the responsiveness of quantity demanded to a change in price. A demand curve is considered elastic if a small change in price leads to a large change in quantity demanded, and inelastic if a large change in price leads to a small change in quantity demanded.
The kinked demand curve model suggests that firms will face a relatively elastic demand for their product on the high-price side of the kink. This means that if the firm raises its price, it will experience a significant decrease in quantity demanded. In contrast, on the low-price side of the kink, the demand for the firm's product is relatively inelastic, meaning that a decrease in price will not lead to a significant increase in quantity demanded.
The kinked demand curve model can help to explain why firms may not always lower their prices in response to a decrease in market demand. If a firm were to lower its price on the high-price side of the kink, it would experience a significant increase in quantity demanded, but it would also experience a decrease in revenue due to the lower price. In contrast, if the firm were to keep its price the same, it would not experience as large of an increase in quantity demanded, but it would also not experience a decrease in revenue. As a result, the firm may choose to keep its price constant, even in the face of a decrease in market demand.
There are several factors that can influence the shape and location of a kinked demand curve. One of the most important factors is the level of competition in the market. In a highly competitive market, firms may be more likely to lower their prices in response to a decrease in market demand, as they seek to remain competitive and attract customers. In contrast, in a market with fewer competitors, firms may be more likely to keep their prices constant, as they have less pressure to lower their prices in order to attract customers.
Another important factor that can influence the shape and location of a kinked demand curve is the availability of substitutes for the firm's product. If there are many substitutes available, the demand for the firm's product may be more elastic, as customers have more options to choose from. In contrast, if there are few substitutes available, the demand for the firm's product may be more inelastic, as customers have fewer options to choose from.
In summary, the kinked demand curve is a useful model for explaining why firms may not always lower their prices in response to a decrease in market demand. The model takes into account the presence of two different elasticities of demand, as well as the influence of factors such as competition and the availability of substitutes. Understanding the kinked demand curve can help firms make informed pricing decisions and better understand the dynamics of their market.
