The Kinked-Demand curve theory is an

economic theory Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...

regarding

oligopoly An oligopoly (from Greek ὀλίγος, ''oligos'' "few" and πωλεῖν, ''polein'' "to sell") is a market structure in which a market or industry is dominated by a small number of large sellers or producers. Oligopolies often result from ...

and

monopolistic competition Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other, but selling products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect ...

. Kinked demand was an initial attempt to explain

sticky Sticky may refer to: People *Sticky (musician), alias of UK garage producer Richard Forbes * Sticky Fingaz or Sticky (born 1973), nickname of the US rapper and actor Kirk Jones Adhesion *Adhesion Adhesion is the tendency of dissimilar ...

prices.

Theory

"Kinked" demand curves and traditional

demand curve In economics, a demand curve is a graph depicting the relationship between the price of a certain commodity (the ''y''-axis) and the quantity of that commodity that is demanded at that price (the ''x''-axis). Demand curves can be used either for ...

s are similar in that they are both downward-sloping. They are distinguished by a hypothesized concave bend with a discontinuity at the bend - the "kink." Therefore, the first derivative point is undefined and leads to a

jump discontinuity Continuous functions are of utmost importance in mathematics, functions and applications. However, not all functions are continuous. If a function is not continuous at a point in its domain, one says that it has a discontinuity there. The set of ...

in the

marginal revenue Marginal revenue (or marginal benefit) is a central concept in microeconomics that describes the additional total revenue generated by increasing product sales by 1 unit.Bradley R. chiller, "Essentials of Economics", New York: McGraw-Hill, Inc., ...

curve. Classical economic theory assumes that a profit-maximizing producer with some market power (either due to

) will set

marginal costs In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...

equal to

. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve . In classical theory, any change in the marginal cost structure or the marginal revenue structure will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve, marginal costs could change without necessarily changing the price or quantity.

Formulation

The two seminal papers on kinked demand were written nearly simultaneously in 1939 on both sides of the Atlantic.

Paul Sweezy Paul Marlor Sweezy (April 10, 1910 – February 27, 2004) was a Marxist economist, political activist, publisher, and founding editor of the long-running magazine ''Monthly Review''. He is best remembered for his contributions to economic theory ...

of Harvard College published "Demand Under Conditions of Oligopoly." Sweezy argued that an ordinary demand curve does not apply to

markets and promotes a kinked demand curve. From Queen's College in

Oxford Oxford () is a city in England. It is the county town and only city of Oxfordshire. In 2020, its population was estimated at 151,584. It is north-west of London, south-east of Birmingham and north-east of Bristol. The city is home to the ...

Robert Lowe Hall Robert Lowe Hall, Baron Roberthall (6 March 1901 – 17 September 1988) was an Australian-born economist who served as chief economic advisor to the British government from 1947 to 1961. Life Robert Hall was born in Tenterfield, New South Wales, ...

and

Charles J. Hitch Charles J. Hitch (January 9, 1910 – September 11, 1995) was an American economist and Assistant Secretary of Defense from 1961 to 1965. He later served as vice chancellor (1965–1967) and president (1967–1975) of the University of California a ...

wrote "Price Theory and Business Behavior," presenting similar ideas but including more rigorous empirical testing, including a business survey of 39 respondents in the manufacturing industry. Hall and Hitch further present a hypothesis for the initial setting of prices; this explains why the "kink" in the curve is located where it is. They base this on a notion of "full cost" -

marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...

of each unit plus a percent of overhead costs or

fixed costs In accounting and economics, 'fixed costs', also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or re ...

with an additional percent added for profit. They emphasize the importance of industry tradition in history in determining this initial price, noting further, "An overwhelming majority of the entrepreneurs thought that a price based on full average cost…was the ‘right’ price, the one which ‘ought’ to be charged."

Criticism

Others such as

George Stigler George Joseph Stigler (; January 17, 1911 – December 1, 1991) was an American economist. He was the 1982 laureate in Nobel Memorial Prize in Economic Sciences and is considered a key leader of the Chicago school of economics. Early life and ...

have argued against kinked demand. His primary opposition is summarized in a Working Paper out of the

Stanford University Stanford University, officially Leland Stanford Junior University, is a private research university in Stanford, California. The campus occupies , among the largest in the United States, and enrolls over 17,000 students. Stanford is consider ...

Economics Department by seminal authors Elmore, Kautz, Walls et al. New classical economists, led by Chicago’s

, worked to discredit the kinked demand models. Stigler first argues that the kinked demand models are not useful, as Hall and Hitch’s model only explains observed phenomenon and is not predictive. 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. Stigler also asserts that the model is unnecessary because Chicago theory already included allowances for short-run sticky prices due to collusion, menu costs, and regulatory or bureaucratic inefficiencies in markets.

Contemporary reformulation

Game theory and models of strategic interaction have largely replaced kinked demand to explain price dislocations and slowly adjusting prices. For further information see:

Reading on contemporary applications

*A Duopoly Price Game *A Theory of Dynamic Oligopoly, Price Competition, Kinked Demand Curves, and Edgeworth Cycles * Competition in the Aluminium Industry 1945-58 *The Kinked Demand Curve: A Game-Theoretic Approach V. Bhaskar "The Kinked Demand Curve: A Game-Theoretic Approach," ''International Journal of Industrial Organization'' 6, (1998): 373.

Notes

{{reflist

References

* Bhaskar, V. 1988. "The Kinked Demand Curve: A Game-Theoretic Approach" ''International Journal of Industrial Organization'' Vol. 6, pp. 373-384. * Hall, R. and Hitch, C. 1939. "Price Theory and Business Behaviour" ''Oxford Economic Papers'' Vol. 2, pp. 12-45. * Maskin, E. and Tirole, J. 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles" ''Econometrica'' Vol. 56, pp. 571-599. * Osborne, D. 1974. "A Duopoly Price Game" ''Economica'' Vol. 41, pp. 157-175. * Peck, M. 1961. ''Competition in the Aluminium Industry: 1945-58.'' Harvard University Press, Cambridge. * Reid, G. 1981. ''The Kinked Demand Curve Analysis of Oligopoly: Theory and Evidence.'' Edinburgh University Press, Edinburgh. * Stigler, G. 1947. "The Kinky Oligopoly Demand and Rigid Prices" ''The Journal of Political Economy'' Vol. 55, pp. 432-449. * Stigler, G. 1978. "The literature of economics: the case of the kinked oligopoly demand curve" ''Economic Inquiry'' Vol. 16, pp. 185–204. * Sweezy, P. 1939. "Demand Under Conditions of Oligopoly" ''The Journal of Political Economy'' Vol. 47, pp. 568-573.

*Bhaskar, V., S. Machin and G. Reid "Testing a Model of the Kinked Demand Curve." ''The Journal of Industrial Economics'' 39, no. 3 (March 1991): 241-254. *Borenstein, Severin. "Evolution of U.S. Airline Competition." ''The Journal of Economic Perspective''s 6, no. 2 (Spring 1992):45-73. *"Economic focus: Sticky situations," ''The Economist'', 11 November 2006, 88. *Elmore, Kautz, Walls et al."Kinked Expectations", Working Paper, Stanford University. *Greenwald, B., J.E. Stiglitz. "Keynesian, New Keynesian and New Classical Economics." ''Oxford Economic Papers'', n.s., 39, no.1 (March 1987): 119-133. *Jones, Kit. ''An Economist Among Mandarins: A biography of Robert Hall'' (1901-1988). Cambridge: Cambridge University Press, 1994. *Meister, J. Patrick. "Oligopoly: An In-Class Economic Game." ''The Journal of Economic Education'', vol. 30, no. 4. (Autumn, 1999): 383-391. *O'Brien, D.P. ''The Classical Economists Revisited''. Princeton: Princeton University Press, 2004. *Primeaux, Walter J. and Mark R. Bomball. "A Re-examination of the Kinked Oligopoly Demand Curve." ''The Journal of Political Economy'' 82, no. 4 (1974): 851-62. *Primeaux, Walter J. and Mickey C. Smith. "Pricing Patterns and the Kinky Demand Curve." ''The Journal of Law and Economics'' 19, no. 1 (1976):189-99. *Rothschild, K. W. "Price Theory and Oligopoly." ''The Economic Journal'' 57, no. 227 (September 1947): 299-320. *"Round Table on Monopolistic and Imperfect Competition." ''American Economic Review'' 27, no. 2. (June 1937): 324-326. *Sawyer, Malcolm. "Post-Keynesian and Marxian Notions of Competition: Towards a Synthesis." In ''Competition, Technology and Money: Classical and Post-Keynesian Perspectives'', ed. Mark A. Glick, 3-22. Brookfield, VT: Edward Elgar Publishing Co., 1994. *Sen, Debapriya. "The Kinked Demand Curve Revisited." ''Economics Letters'' 84 (2004):99-105. *Simon, Julian L. "A Further Test of the Kinky Oligopoly Demand Curve." ''The American Economic Review'' 59, no. 5, (1969): 971-975. *Smith, Victor E. "Note on the Kinky Oligopoly Demand Curve." ''Southern Economic Journal'' 15, no.2, (1948): 205-210. *Stein, Jerome L. ''Monetarist, Keynesian, and New Classical Economics''. Oxford: Basil Blackwell Publishing, 1982. *Managerial Economics. "G S Gupta" Demand Imperfect competition