A kink in an SD curve, also known as a kinked demand curve, represents a situation where a firm faces a different price elasticity of demand for its product depending on whether it raises or lowers its price.
This concept is typically used in oligopoly market structures, where a few firms dominate the market and are highly interdependent.
Imagine a firm considering a price increase. If the firm believes its competitors will follow suit and raise their prices, it may face a relatively inelastic demand curve because consumers have fewer substitutes available. However, if the firm believes its competitors will keep their prices constant, it may face a more elastic demand curve as consumers switch to competitors' products.
This creates a kink in the demand curve, where the slope changes abruptly at the current price point.
The kinked demand curve model helps explain why prices in oligopolistic markets tend to be sticky, meaning they are reluctant to change. Firms are hesitant to raise prices because they fear losing market share, and they are hesitant to lower prices because they fear sparking a price war.
Key features of a kinked demand curve:
- Two different demand elasticities: The demand curve is more elastic above the current price and less elastic below the current price.
- Discontinuity: There is a discontinuity in the demand curve at the current price point.
- Sticky prices: Prices tend to be stable and resistant to change, even in the face of changes in costs.
Examples:
- The automobile industry is an example of an oligopoly where kinked demand curves may be observed. If one automaker raises prices, others may follow suit, leading to a less elastic demand. However, if one automaker lowers prices, others may be hesitant to match, leading to a more elastic demand.
- The airline industry is another example. If one airline raises fares, others may follow, leading to a less elastic demand. However, if one airline lowers fares, others may be hesitant to match, leading to a more elastic demand.
