A kink in demand curve is a sharp change in the slope of the demand curve. It occurs when there is a sudden increase or decrease in demand at a specific price point. This can be caused by various factors, including government intervention, technological advancements, or changes in consumer preferences. The four entities closely related to a kink in demand curve are: price ceiling, price floor, subsidy, and tax.
The Kinked Demand Curve Explained
The kinked demand curve is an economic model that represents the demand for a product or service facing a kink that prevents a smooth movement along the curve. This kink usually results from imperfect competition in an oligopoly market where only a few dominant firms exist.
Characteristics of the Kinked Demand Curve:
- It consists of two segments, a steeper upper segment and a flatter lower segment.
- The kink point represents the prevailing price level.
- Demand is highly elastic above the kink point (upper segment).
- Demand is relatively inelastic below the kink point (lower segment).
Explanation:
In an oligopoly, firms are interdependent, meaning they consider the actions of their competitors when making pricing decisions. The kink in the demand curve captures this interdependence:
- If a firm raises its price above the kink point (upper segment), other firms are more likely to hold their prices steady, as they expect customers to switch to the lower-priced rivals. This leads to a high elasticity of demand.
- Conversely, if a firm lowers its price below the kink point (lower segment), other firms may follow suit to prevent losing market share. This results in a lower elasticity of demand.
Implications:
- Pricing Stability: The kink prevents firms from making significant price changes, maintaining a state of pricing stability.
- Entry Barriers: The threat of retaliatory pricing from incumbents creates a barrier to entry for new firms.
- Collusion: The kinked demand curve provides an implicit form of collusion, as firms avoid risking price wars that would erode profits.
Example:
Consider a market with two gasoline companies, GasCo and Petro.
- If GasCo raises its price, Petro is unlikely to follow, leading to a decrease in demand for GasCo’s gasoline.
- However, if GasCo lowers its price, Petro is likely to match the price reduction, resulting in only a small increase in demand for GasCo’s gasoline.
| Price Change | Demand Elasticity | Impact on GasCo’s Sales |
|---|---|---|
| Increase above kink | High | Small decrease |
| Decrease below kink | Low | Small increase |
In conclusion, the kinked demand curve is a useful model that explains the unique pricing behavior in oligopolistic markets. It highlights the interdependence of firms and the resulting barriers to price competition.
- Question: What is a kink in demand curve?
Answer: A kink in demand curve occurs when there is a discontinuity or slope change in the curve. This means the curve changes direction or slope at a specific point, indicating a sudden shift in consumer behavior.
- Question: Can government policy cause a kink in demand curve?
Answer: Yes, government policies such as taxes, subsidies, or price regulations can induce a kink in demand curve. These policies influence consumer preferences and willingness to purchase, thereby altering the shape of the demand curve.
- Question: What is the difference between price elasticity and kink in demand curve?
Answer: Price elasticity measures the responsiveness of quantity demanded to changes in price. A kink in demand curve, on the other hand, signifies an abrupt change in demand regardless of price fluctuations. While related, they represent distinct concepts in economics.
Whew, there you have it. From understanding the basics to exploring the complex reasons behind a kink in demand curve, we hope you’ve got a solid grasp on this intriguing concept. Thanks for sticking with us on this journey into economics. Remember to check back with us soon, we’ve got plenty more interesting stuff up our sleeves!