How realistic are the assumptions of the kinked demand model? How far does it aid our understand

How realistic are the assumptions of the kinked demand...

Key Concepts

Kinked Demand Model

The kinked demand model is a theoretical construct used in oligopolistic market analysis to explain price stability despite changes in marginal cost. It assumes that if a firm raises its price, competitors will not follow, causing a significant loss of market share, whereas if it lowers its price, competitors will also lower theirs, resulting in little gain for the initiating firm. This asymmetric reaction creates a ‘kink’ in the demand curve, which in turn causes a discontinuity in the marginal revenue curve, lending an explanation for price rigidity observed in some markets.

Assumptions and Limitations

This concept involves several assumptions that are critical to its function, such as the belief that competitors have asymmetric responses to price changes and that firms have similar cost structures. In practice, these assumptions may not hold true in all real-world scenarios, as competitive behavior can be more complex and market conditions heterogeneous. The criticism of these assumptions lies in their oversimplification of strategic interactions among firms and the inability of the model to account for dynamic market factors, thus limiting its overall predictive power.

Oligopolistic Price Determination

In an oligopoly, where a few large firms dominate the market, pricing decisions are interdependent. Each firm's decision to adjust prices is heavily influenced by expectations about competitors’ reactions. The kinked demand model provides one framework to understand how these interdependencies might lead to price stickiness. However, it does not fully capture other strategic elements such as product differentiation, entry barriers, or collusive behavior, which are also influential in determining prices in oligopolistic environments.

Application to Specific Industries

The application of the kinked demand model to specific industries, such as the airline sector, serves as an illustrative case for assessing the model’s strengths and weaknesses. While the model can highlight why prices might remain relatively stable over time in certain market conditions, its assumptions may be too rigid or simplistic when examining industries with complex competitive dynamics, fluctuating demand, and regulatory influences. This limits the model’s effectiveness in fully explaining the pricing behavior observed in such markets.

Transcript

00:01 So let's answer the following questions, and the first question is that what assumptions about a rival's response to price changes underlie the kind of demand call for oligopolis? so your assumption for a kind of demand call for an oligopolis would be some assumptions would be one.

00:47 There are only few firms in the market.

01:03 Another assumption is that the quality of products remains constant.

01:23 Another assumption is that rival will match cuts.

01:32 Another assumption is that all firms producing a producing closed substitute products.

01:54 And the final assumption is that rival will ignore price increases.

02:10 So now, let's move it to the second part of the question.

02:14 This one says, why is there a gap in the oligopolist marginal revenue curve? so we can say that there is a gap in the oligal police marginal revenue curve the reason for the gap is because since the marginal revenue curve is um depends on the price so if the firm lowers its price then other firms will also decrease their price to avoid losing your customers right so that leads to a kink in the demand curve and automatically a kink in the a king or a gap in the demand in the marginal revenue curve.

03:04 So there's a gap in the oligopoly's marginal curve because the marginal revenue curve depends on the price.

03:24 So if a firm reduces price, other firms would also decrease their price.

03:46 And this leads to a king in the demand curve and also a gap in the marginal revenue curve.

04:20 So that's why there's a gap in the marginal revenue curve of the oligopoly...

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