Peck, Competition in the Aluminium Industry 1945-58, Cambridge: Harvard University Press, 1961. For avoiding such type of problems, organizations enter into an agreement regarding uniform price-output policy. In such a case, consumers would switch to rivals, which would lead to fall in the sales of the oligopolistic organization. For example, if a firm agrees to collude and set low output — it relies on the other firm sticking to the collusive agreement. This is illustrated in Fig.
. But, if they can stick to their quotas and keep the price at P2, they make supernormal profit. In other words, each oligopolist will adhere to the prevailing price seeing no gain in changing it. The kinked demand curve model This model suggests that prices will be fairly stable and there is little incentive for firms to change prices. Therefore, although the kinked demand curve model cannot explain the process of price determination, it can well explain why the prices are sticky in an oligopolistic market. Other Models Explaining Price Stability in Oligopoly Marginal Cost Plus Pricing. Prices do change in Oligopolistic markets much more often than this model suggests.
Why the Kink in the Demand Curve? When there is a rise in cost of industry an oligopolist can reasonably expect that his increase in price will be followed by the others in the industry. Some of the major points of criticism are as follows: i. Oxford: Basil Blackwell Publishing, 1982. As has been explained above, in the context of decreased demand, price in kinked demand curve theory is likely to remain sticky. It is worth mentioning that the marginal revenue curve associated with a kinked demand curve is discontinuous, or in other words, it has a broken vertical portion. For example, where reverse logistics was only recently a differentiated, value added service to major shippers, full return service visibility is now the new norm for individual consumers.
If the firm restricts output sets the High price , and then the other firm betrays its agreement setting low price. Fourth, in the model under discussion, the firm may not have to change the price of its product, even if its cost of production rises. It has been observed that many oligopolistic industries exhibit an appreciable degree of price rigidity or stability. Definition of oligopoly An oligopoly is an industry dominated by a few large firms. First, it does not explain how the oligopolist finds the kinked point in its market demand curve. Moreover, the profits would remain same between point X and Y. He further explains that the kinked demand analysis only suggests why prices remain sticky and does not describe the mechanism that establishes the kink and how the kink can reform once prices change.
Therefore demand will only increase by a small amount. As they become more social and start to learn on their own i. Under collusion, organizations are involved in collaboration with each other to take combined actions for keeping their bargaining power stronger against consumers. It follows from the above discussion that the larger the difference between e, and e 2, i. George Nemhauser and several others. The most predominant one being the kinked demand curve model, though this has received substantial criticism and economists have put forward other explanations. Kinked Demand Curve The Kinked demand curve suggests firms have little incentive to increase or decrease prices.
Let us understand price and output decisions under cartels with the help of an example. Stigler also asserts that the model is unnecessary because already included allowances for short-run sticky prices due to collusion, menu costs, and regulatory or bureaucratic inefficiencies in markets. As a result, demand curve facing a firm under differentiated oligopoly is not perfectly elastic. Therefore, firms compete using non-price competition methods. Game Theory looks at the behaviour of firms when there is interdependence. This enables the industry to become more profitable. The firm will be worse off.
When oligopolists follow each others pricing decisions, consumer demand for each oligopolist's product will become less elastic or less sensitive to changes in price because each oligopolist is matching the price changes of its competitors. In some oligopolies, there may be an element of price leadership. Thus it follows from the kinked demand curve theory that price is not likely to remain stable in the event of rise in cost. Therefore, to understand the kinked demand curve model, it is important to note the reactions of rival organizations on the price changes made by respective oligopolistic organizations. A kinked demand curve represents the behavior pattern of oligopolistic organizations in which rival organizations lower down the prices to secure their market share, but restrict an increase in the prices.
The points of intersection E 1 and E 2 are the equilibrium levels of the organizations, A and B, respectively. Non-price competition can be in terms of product differentiation, advertising, and other tools used by organizations to promote their sales. Large reduction in sales following an increase in price above the prevailing level by an oligopolist means that demand with respect to increases in price above the existing one is highly elastic. Therefore, price and output would remain stable. However, kinked demand curve model is criticized by various economists. There is no unique general solution but merely many different behavioral models, each of which reaches a different solution.
Hitch on the other hand. Some of the benefits of collusion are as follows: i. This is reinforced in situations where the customers understand the cost model. However, if firms collude, they can agree to restrict industry supply to Q2, and increase the price to P2. These two different types of reaction of the competitors to the increase in price on the one hand and to the reduction in price on the other make the portion of the demand curve above the prevailing price level relatively elastic and the lower portion of the demand curve relatively inelastic.