Introduction
Oligopoly is a market structure in which a few large firms dominate the market. One of the key characteristics of oligopoly is price rigidity — prices tend to remain stable even when costs or demand change. Economist Paul Sweezy attempted to explain this phenomenon using the Kinked Demand Curve Model. This model is based on the behaviour of competing firms in an oligopolistic market. In this answer, we will explain the kinked demand curve theory and how it shows price rigidity.
Paul Sweezy’s Kinked Demand Curve Model
Sweezy developed this model in the 1930s to explain why prices in an oligopoly do not change frequently, even if costs or demand conditions change. According to Sweezy, each firm in an oligopoly believes that:
- If it lowers its price, competitors will follow by also lowering their prices, leading to no gain in market share.
- If it raises its price, competitors will not follow, and the firm will lose customers to rivals.
This belief results in a demand curve that has a “kink” at the current price.
Shape of the Kinked Demand Curve
The demand curve under Sweezy’s model has two segments:
- Above the current price: The demand curve is more elastic (flatter) because if a firm raises its price, other firms do not follow. Consumers will shift to competitors, and demand will fall sharply.
- Below the current price: The demand curve is less elastic (steeper) because if a firm lowers its price, others also reduce theirs, resulting in a small gain in market share.
This creates a kink at the current market price, leading to a discontinuous marginal revenue (MR) curve.
Price Rigidity Explained
Because of the kink in the demand curve, the marginal revenue (MR) curve has a vertical discontinuity (a gap) at the point of the kink. If marginal cost (MC) lies anywhere within this discontinuous portion, the firm has no incentive to change its price or output. Thus, even if costs change within a certain range, the price remains the same.
Example:
- If MC increases slightly, it may still lie within the MR gap — so price and output do not change.
- If MC decreases slightly, the firm again sees no gain in changing the price, due to competitors matching its move.
Graphical Illustration (Conceptual Description)
The kinked demand curve looks like this:
- The demand curve has a bend or kink at the current price and quantity.
- The upper part of the curve is elastic, and the lower part is inelastic.
- The MR curve has a vertical gap (discontinuity) below the kink.
This gap in the MR curve explains why the firm does not change its price — there’s no profit gain in doing so.
Criticisms of the Model
- It does not explain how the original price is set in the first place.
- It assumes price rigidity, but not all oligopolies show this behaviour.
- It does not account for non-price competition like advertising and product quality.
Conclusion
Paul Sweezy’s kinked demand curve model explains the concept of price rigidity in oligopolistic markets. Firms avoid changing prices because they fear losing customers or starting a price war. The kink in the demand curve and the resulting discontinuity in the MR curve create a zone of stability. Despite its limitations, the model is useful in understanding why prices in oligopoly remain unchanged even when costs or demand fluctuate.