(Kinky Demand Curve) Short Period

Kinked demand curve was first used by Prof. Paul M. Sweezy to elucidate price rigidity under oligopoly. In an oligopoly market, firm knows that if it increases price, other firms won't follow; though if price is reduced, other firms will follow price reduction. In some respect, price output analysis in oligopoly is simple. Because every seller wants to avoid uncertainty, each oligopolistic firm will adhere to the point of kink where itis safe and where it can anticipate the reaction of its rivals. Though the firm will neither decrease nor increase price.

Figure: Kinked Demand Curve

This is a significant consequence of the existence of the kink in demand curve of firm. Since of the vertical section in MR, which is uncertainty range, without affecting the price or level of output. Under these situations, equality between MR and MC won't determine the point of equilibrium. The profits will, though, be determined as in any other market, by difference between AC andAR. With a given marginal cost of production, OP is more about to be the profit-maximising price. Length of the discontinuity portion in MR relies on the relative elasticity of demand at point E of AR. The greater the elasticity of demand of portion of AR above point E and the lower the elasticity of demand of the portion of AR below point discontinuity portion of MR, the bigger will be discontinuity portion of MR. Figure above demonstrates that price is fixed at OP and output is OM.