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Kinked demand curve

Definition

The kinked demand curve is a model used to explain the behavior of firms in an oligopoly market. It suggests that when a firm raises its price, other firms will not follow suit, resulting in a highly elastic demand for the firm's product. However, if the firm lowers its price, other firms are likely to match it, leading to an inelastic demand.

Analogy

Imagine you and your friends are selling lemonade on a hot summer day. If one friend decides to raise their price, customers will quickly switch to buying from another friend who kept their price low. But if one friend lowers their price, everyone else will also lower theirs to compete for customers.

Related terms

Colluding oligopolies: This refers to a situation where firms in an oligopoly market secretly cooperate with each other by setting prices or output levels together in order to maximize profits.

Cartels: Cartels are formal agreements between competing firms in an industry where they agree on production quotas and pricing strategies. They aim to reduce competition and increase profits collectively.

Price leadership: Price leadership occurs when one dominant firm sets the price for the entire industry and other firms follow suit. The leader typically has significant market power and influence over pricing decisions.