What is the kinked demand curve model and why is the optimum price point at the level of the kin

What is the kinked demand curve model and why is the optimum...

Key Concepts

Kinked Demand Curve Model

This model illustrates how firms in an oligopolistic market structure face a demand curve that changes its slope at a particular price, known as the kink. Above the kink, demand is more elastic because competitors are likely to match any price cut, while below the kink, demand is less elastic since competitors may not follow price increases. This creates a discontinuity in the marginal revenue curve, affecting price-setting behavior among firms.

Marginal Revenue Discontinuity

Due to the kink in the demand curve, the marginal revenue curve is discontinuous at the output level corresponding to the kink. The sudden drop in marginal revenue means that small changes in output have unpredictable effects on revenue, which can result in firms being less responsive to shifts in market demand, ultimately contributing to price rigidity.

Oligopoly Market Structure

In markets characterized by a few dominant firms, the strategic interdependence of pricing decisions becomes crucial. The kinked demand curve model is particularly relevant in this context, as firms are uncertain about how competitors will react to price changes, leading to a situation where it is often optimal to maintain the current price to avoid destabilizing the market.

Optimum Price Point

The optimum price point is found at the kink because here the marginal revenue is highly sensitive, and any deviation from this price could trigger aggressive competitive responses. The discontinuity in marginal revenue creates a sort of 'price stickiness,' where the current price is maintained, even in the face of changes in economic conditions, thus reinforcing the equilibrium at the kink.

Transcript

00:01 All right, so today we're going to be introducing the demand curve and the qualities that go into making the demand curve, you know, what the actual calculations are behind it, why it's inversely sloped, and just the broad basics of the demand curve.

00:21 So let's start off by looking at the law of demand.

00:25 So what the law of demand states is that there's a negative relationship between price and quantity demanded when all else, all their variables are held constant.

00:38 So the key thing from this definition of the take of is it's a negative relationship, right, between the price and quantity when factors are held constant.

00:50 Now, what these factors include are things such as, let's say, price, consumer income, sorry, consumer income, let's say quality advertisement, and just a bunch of other factors that go into influencing the consumers ' thoughts and demand for a certain.

01:18 So what we're going to do when we talk about the broad basis of demand is hold all this constant, right? assuming that this just doesn't exist.

01:28 It's all the same and just focusing on the two key terms, which is price and quantity.

01:36 So actually, yeah, sorry, price we will actually be looking at here.

01:40 That's not part of the factor that we'll admit for now.

01:43 So let's look more into the negative relationship factor here.

01:46 So let's draw a simple supply demand curve.

01:50 Now it looks like this.

01:52 You may be asking why this demand is negatively slow.

01:57 So let's walk through that.

01:59 So suppose we buy an apple, right? we go to a store to buy an apple.

02:05 Again, we're not looking at how much money we have, the quality company of apples, whatever.

02:10 We're just looking at the apple, right? so suppose it costs five bucks.

02:15 And suppose there's another one that costs.

02:17 $2.

02:18 Now, if you only have a certain amount of money to spend, we will obviously want to buy the one that's cheaper, right? we will buy more quantity, right? so suppose we buy like seven.

02:30 We will buy more quantity of the cheaper apple as compared to the more expensive one, right? right here.

02:39 Suppose we only buy three.

02:39 So for five bucks an apple, we will buy three of them.

02:43 For two bucks, we will buy seven of them.

02:44 And that's just that's just a broad concept.

02:48 Very self -explanatory.

02:50 When something costs less, consumers will be able to spend more money on it and would more likely purchase the cheaper option.

03:00 We can also look at something called the law of diminishing returns.

03:11 Diminishing returns.

03:12 Sorry for the handwriting.

03:14 I hope you guys can read it.

03:15 It's a law of diminishing return...