Models of Oligopoly (With Graphs and Criticisms)

Models of oligopoly – 1. Cournot’s Duopoly Model 2. Bertrand’s Duopoly Model 3. Edgeworth Duopoly
Model 4. Chamberlin’s Oligopoly Model.

1. Cournot’s Duopoly Model:

In 1838, A French economist, Augus�n Cournot has developed a model on oligopoly. Cournot’s model
dealt with the case of duopoly.

The duopoly model of Cournot is based on the following assump�ons:

1. There are only two producers each owing iden�cal mineral springs. Their waters are iden�cal. This
assump�on means that the products are homogeneous.
2. The cost of produc�on of both the firms is zero. The owners operate mineral springs and sell water
without incurring any cost of produc�on. The Cournot’s model can be presented when cost of
produc�on is posi�ve.
3. Each firm acts on the basis of the assump�on that in spite of his ac�ons and their impact upon
market price of the product, the rival firms will con�nue with the same level of output. In other
words, the rival firms will go on producing the same amount of output which they are presently
producing.
4. The market demand for the product is assumed to be linear and the market demand curve facing
the two producers is a straight line. Both the firms know the market demand properly.

In Cournot’s model the mineral spring owner will not take into account reac�ons of his rival in response
to his varia�on in output and thus decides its level of output independently.

Let us suppose that the demand curve of the two producers of the mineral water is represented by the
straight line RQ as shown in Figure 9.4. Further suppose that OD = DQ is the maximum daily output of each
mineral spring. Thus, the total output of both the springs is OQ = OD + DQ.

It is important to note that the 9.6 total output OQ of both the springs is available for sale in the market
at zero prices. It may be further noted that if perfect compe��on would have prevailed, the long-run
equilibrium price would have been zero and actual output produced equal to OQ. Since the cost of
produc�on is assumed to be zero the price must also be zero so as to provide a zero profit long-run
equilibrium under perfect compe��on.

At the outset of the model, there is one producer (firm) called A of the mineral water to start the business.
Therefore, to begin with the only producer will behave like a monopolist. He /She will produce daily OD
level of output because the profits will be maximum at output OD and will be equal to ONMP. As it is
assumed that costs of produc�on are zero, the whole of total revenue ONMP would accrue as profit.
OP is the price charged by the single producer A. At this stage, let us suppose that the owner of the other
spring owner say B enters into the business and starts opera�ng his/her spring. This new producer B sees
that the former producer A is producing ON amount of output.

It has been assumed that each firm believes that its compe�tors will not react to the decision taken by an
individual firm. Accordingly the producer B believes that the former producer A will con�nue producing
OD (= 1/2 OQ) amount of output, irrespec�ve of the output he himself produces. In this situa�on, the new
producer B will consider segment MQ as his/ her demand curve lacing him/her. With the demand curve
MQ, the producer B will have MR2, as marginal. The producer B will therefore produce NI (= 1/2 DQ)
amount of output. At this point of �me, the total output will now be OD + DH = OH, and as a result the
price will fall to OP1.

As the Price level falls to OP1, the total profits made by the two producers will be OIBP1 which are lesser
than ODMP. When OIBP1 is the total profit, producer A will earn profits equal to ODGP1 and producer B
will earn profit equal to DIBA. It can therefore be observed that the entry of producer B into the market
producing output DI by him, the profit of producer A has been reduced.

In this situa�on, the producer A will have to review the situa�on. But as embodied in the assump�ons of
the model, producer A will assume that producer B will con�nue to produce output DI. Having assumed
that the producer B will be producing output DI, the producer A will produce 1/2 (OQ -DI). Thus, producer
A will reduce his output.

At this point, the producer B will be surprised as the producer A has reduced the output and as a result
producer B will also find that his/her share of total profits is less than that of producer A. Producer B will
have to reconsider the situa�on. But as obvious from the assump�ons, producer B will learn nothing from
the earlier experience and will again assume that producer A shall con�nue producing the new current
level of output. The producer B will find that he will now be making maximum profits by producing output
equal to 1/2 (OQ – New output of A).
The producer B will increase his/her output accordingly. As a consequence of the move of producer B,
producer A will find his/her profits reduced. The producer A will again therefore need to reconsider his
posi�on and will start producing output equal to 1/2 (OQ – Current output of producer B) assuming that
producer B will not react to the change made by producer A.

It is interes�ng to note that the process of adjustment and readjustment among the producers will
con�nue and as a result the producer A is forced gradually to reduce his/her output and producer B will
be able to increase his/her output gradually un�l the total output OG is produced . The total output
produced (OG) is 2/3 of the OQ. i.e.., (OG = 2/3 OD) and each of the producer produces the same amount
of output which is equal to 1 /3 OQ.

As represented in the figure, in the final posi�on among the both producers, producer A produces OH
amount of the output and producer B produces HG amount of output. In the en�re course of adjustments
each of the producer assumes that the other compe�tor will keep his/her output constant at the current
level and finds the maximum profit by producing output which is equal to 1/2 (OQ- the current output of
the rival producer).

In Cournot’s duopoly model both the producers combine to produce two-thirds of the maximum possible
output. Cournot’s model can be extended to those cases of oligopoly where there are more than two
sellers. If there were n producers, then according to Cournot’s duopoly solu�on the total output produced
by the n producers would be n/n+1 of the maximum possible output.

Here we would pause to compare the case of Cournot’s duopoly equilibrium with the monopoly and the
perfectly compe��ve equilibriums.

Comparison of Cournot’s Duopoly Solu�on with Monopoly:

Let us imagine that if both the producers A and B considered in the above model had combined and formed
a coali�on, then the output produced by A and B together would have be the monopoly output OD. The
price in that situa�on would have be the monopoly price OP. It can be observed that the monopoly output
OD produced by A and B together is much less than the output OG produced in Cournot’s equilibrium
solu�on. Moreover, the monopoly price OP charged in case of coali�on is much greater than the price OP,
determined in Cournot’s model. If we consider that producers A and B earn the monopoly profits ODMP.
This profit is greater than the OGFP2 made by the producers A and B in Cournot’s duopoly equilibrium.

Comparison of Cournot’s Duopoly Solu�on with Perfect Compe��on:

Let us again imagine a situa�on when the market is a perfectly compe��ve one. In that situa�on the
output would have been OQ and price would have been zero. The price would be zero owing to the
assump�on that in Cournot’s model the marginal cost is zero.

Accordingly, equilibrium in perfect compe��on is possible only when the price is equal to zero. In the
situa�on of perfect compe��on the output OQ is greater than the output produced in Cournot’s Duopoly
solu�on and the price is lower than the price in Cournot’s duopoly solu�on.
Criticisms:

Even though Cournot’s duopoly model in one of the pioneering efforts made by different economists, the
model has been subject to cri�cism on the following grounds:
1. Each firm in Cournot’s model acts on the basis of the assump�on that in spite of his/her ac�ons
and their impact upon market price of the product, the rival firms will con�nue with the same
level of output. This assump�on is severely cri�cized by the cri�cs.
2. Cri�cs vehemently cri�cize Cournot’s model for ignoring the mutual interdependence between
the duopolis�c firms which is the chief characteris�c of oligopoly
3. The assump�on of zero cost of produc�on reduces the pragma�c nature of Cournot’s model.

In spite of the cri�cisms, the Cournot’s model occupies a important niche in economic theory as well as
business economics.

Cournot’s Duopoly Equilibrium Explained with the Aid of Reac�on Curves:

The Cournot’s duopoly model can be represented with the help of reac�on curves. The reac�on curves
refer to the output reac�on curves or price reac�on curves. The choice of the reac�on curve to be used
depends on the adjus�ng variable used in the model. If output is the adjus�ng variable then output
reac�on curve has to be used and price reac�on curve has to be used when price is the adjus�ng variable.
In Cournot’s duopoly model, output is the adjus�ng variable and therefore output reac�on curves are
relevant.

One has to understand that the reac�on curves don’t refer to the reac�ons which a producer expects will
be forthcoming from his rivals but to the producers’ own reac�ons to the moves of his rival.

2. Bertrand’s Duopoly Model:

In 1883, a French mathema�cian, Joseph Bertrand formulated his duopoly model. Bertrand cri�cized
Cournot’s duopoly model. Bertrand opined that there was no limit to the fell in price since each producer
can always lower the price by underbidding the other and increasing his supply of output un�l the price
becomes equal to his unit cost of produc�on.

Bertrand’s model has some significant differences in the assump�ons as compared to Cournot’s duopoly
model. The adjus�ng variable in Bertrand’s model is price and not output. Bertrand assumes that each
seller (firm) believes that the rival will keep his/her price constant, regardless of his own decision about
pricing. Therefore, in Bertrand’s model both the firms are deemed to face the same market demand and
both the firms will strive to maximize own profit assuming that the price of the rival will remain constant.

We will try to understand the Bertrand’s model using the reac�ons curves of the duopolists. The reac�on
curves are derived from the isoprofit maps. These isoprofit maps are convex to the axes.
Talking about the isoprofit curve, an isoprofit curve for a specific level of profit is represented on the basis
of the different combina�ons of prices charged by the rival firm. To represent the Bertrand’s duopoly
model with the help of the reac�on curves, let us suppose that there are two sellers (firms) namely firm A
and firm B. The figures 9.5a and 9.5b depict the reac�on curves of firm A and firm B respec�vely. As stated
earlier, the reac�on curve of a firm is drawn through its isoprofit curve. The isoprofit curve of a firm is
convex to the respec�ve price axis. In the figures it can be observed that the isoprofit curves of firm A and
firm B are convex to the price axes Pa and Pb respec�vely.

In figure 9.5a we can see that the firm A can earn a given specified profit from the various combina�ons
of its rival’s and own price. The price combina�ons at point r, point s and point t on isoprofit curve n πA1
yield the same level of profit. Now, if firm B fixes its price Pb1, the firm A has the alterna�ves PA1 and to
atain same level of profits. But, if firm B reduces its price further, firm A has to decide whether to raise its
price or reduce its price. Firm A would raise its price above PA1 when it is at point r and firm would reduce
its price when it is at point t where it charges price PA2 .This adjustment of prices has a limit.

This limit is depicted by point s. Therefore, there is unique price for a firm to maximize its profit. The lowest
point of the isoprofit curve represents the unique price. When we join the points r, s, t, we get the curve
πA1. Similarly, we have the other isoprofit curves πA2, πA3. The reac�on curve of firm A can be traced by
joining the lowest points of the isoprofit curves π A1, π A2, π A3

The reac�on curve of firm B can similarly be traced by joining the lowest points of its isoprofit curves as
depicted in figure 9.5b.

Bertrand’s model leads to a stable equilibrium. The equilibrium of the duopoly model presented by
Bertrand is arrived by incorpora�ng the reac�on curves of both the firms A and B in the same figure 9.5c.
Point e is the equilibrium as the reac�on curves of firm A and firm B intersect at point e. This is a stable
equilibrium as because any devia�on from this equilibrium point sets in mo�on forces which will ul�mately
set the equilibrium at point e again.

Bertrand’s duopoly model has been cri�cized for the fallacious assump�ons. The assump�on of the
duopolist not taking the reac�on of the rival into considera�on while deciding its price level is opposed.

3. Edgeworth Duopoly Model:

In 1897 F.Y. Edgeworth, a French economist formulated a duopoly model. Edgeworth cri�cized the
Cournot’s duopoly solu�on. He negated the assump�on made by Cournot in which each duopolist firm
assumes that the rival firm would con�nue to produce the same output regardless of the level of output
produced by the firm.

While formula�ng the model, Edgeworth has made assump�on similar to the assump�on made by
Bertrand in which the firm assumes that his rival firm will con�nue to charge the same price regardless of
the price set by the firm.

Further one should note that Edgeworth has used the example of Cournot’s mineral springs. Therefore, in
Edgeworth’s model the cost of produc�on is zero. One important aspect of Edgeworth’s model is that there
is no determinate equilibrium achieved in the model.

Before we move ahead it is important to note that there is major difference between the Edgeworth’s
model and the Bertrand’s model. In Edgeworth’s model, the produc�ve capacity of each duopolist firm is
limited and neither of the duopolists is able to produce the en�re demand. Unlike Edgeworth’s model in
Bertrand’s model produc�ve capacity of each duopolist firm is prac�cally unlimited so that the firm can
sa�sfy any amount of demand.
Edgeworth’s model of duopoly has been represented in Figure 9.6.There is an assump�on in the model
that the products of two duopolists firms are completely iden�cal. As a implica�on of the assump�on the
market would be equally divided between the two duopolists at the same price of the product.

Let us suppose that there are two firms 1 and 2 in the market. The size of the en�re market is B1 B. The
en�re market B1B is divided into equal parts between the two firms. Both the firms face iden�cal demand
curves. Firm 1 has the demand curve QX and Firm 2 has the demand curve QXb. It can be observed from
the figure the firm 1 has the maximum capacity of OB amount of output and firm 2 has the maximum
capacity of output OB1. Price is measured and represented along OQ ordinate.

At the outset let us imagine that there is a single firm, the firm1 in the market. Being the only firm the firm
will behave as a monopoly. The firm will therefore sell OA amount of output and charge a price equal to
OP. The firm earns profit equal to OPMA. This is owing to the assump�on that the cost of produc�on is
zero. Let us suppose that at this point the other firm viz., the firm 2 enters the market and assumes that
the firm1 will not change its price as the firm1 is enjoying maximum profit and thereby firm2 sets its price
slightly below firm1’s price (OP). By doing this firm 2 is able to sell its total output and also capture a
substan�al part of firm 1’s market.

Now as the firm 1 realizes the reduc�on in its sale, it will set its price slightly below the price of firm2 in
order to regain the lost market. This will ensue a price war between the firms. The price war takes the
form of price cu�ng which con�nues un�l the price reaches OP1. At the price level OP1, both the firms
are able to sell their en�re outputs. The firm1 will sell OB and firm2 will sell BB1 at this price level. The
price level OP1 seems to provide stability to the model. But Edgeworth in his model explain that this price
level is not stable.

There is an inherent instability in the model. The cause for the instability in the model is that, each firm
realizes that its rival is selling its en�re output and it will therefore not be able to alter its price and each
firm thinks that it can raise his price to OP and can make profit. This again sets the chain of ac�ons and
reac�ons. If the firm 1 raises its price to OP. Firm 2 will assume that firm 1 will retain its price level at OP
and finds that if it raises its price to a level slightly below OP it can sell its en�re output at a higher price
and make profit.

As a reac�on to the move of firm 2, the firm 1 will reconsider his situa�on and react. Firm 1 observes that
its price is higher than the price of firm 2 and its sale has reduced. Again assuming firm 2 to retain its price,
firm 1 will reduce its price slightly below the price of firm 2. The price war between both the firms resumes.
This price war con�nues and as a result the price remains unstable and keeps on fluctua�ng i.e., moving
up and down between OP and OP1 where OP is the monopoly price and price OP1 is the compe��ve price.
There is no unique equilibrium in Edgeworth’s duopoly model.

We can thus conclude that in Edgeworth’s duopoly model the equilibrium is indeterminate. The price in
Edgeworth’s duopoly model constantly oscillates between the monopoly price and compe��ve price. The
assump�ons of the Edgeworth’s duopoly model have been cri�cized by the cri�cs.

4. Chamberlin’s Oligopoly Model:

As compared to the classical Oligopoly models of Cournot, Bertrand, and Edgeworth the Chamberlin’s
oligopoly model is compara�vely more advanced and superior. Chamberlin’s model is based on the
assump�on that the oligopolis�c firms understand and recognize the mutual interdependence and behave
accordingly.

Chamberlin opined that the oligopolists are intelligent enough to recognize their interdependence and
they therefore jointly produce monopoly output and charge monopoly price. Thus, in Chamberlin’s model
the stable equilibrium and maximiza�on of joint profit by the oligopolist is accomplished. It is interes�ng
to note that the oligopoly firms behave in a non-collusive manner.

We have tried to illustrate the Chamberlin’s oligopoly model in figure 9.7 Chamberlin assumes that there
are two producers viz., producer 1 and producer 2. The cost of produc�on has been assumed to be zero
and the product produced is homogeneous. Further, the market demand curve DD1 has been assumed to
be linear.

In order to understand the Chamberlin’s model we assume that producer 1 enters the market and is the
first to start produc�on. Producer 1 faces the linear demand curve DD1 represen�ng the whole market.
MR1 is the corresponding marginal revenue curve. Producer 1 will produce OD2 which is half of OD1 which
is equal to the monopoly output and fix monopoly price OP.

Let us suppose that at this point of �me the producer 2 enters the market. The producer 2 assumes that
producer1 would con�nue to produce OD2 output and thus MD1 por�on of market demand curve is the
relevant demand y curve for producer 2 and the corresponding marginal revenue curve for producer 2 is
MR2. Producer2 will find it profitable to produce half of D2D1 which is equal to D2R. This is owing to the
assump�on that marginal cost of produc�on is zero.

Now the total output available in the market becomes equal to OR. The total output OR includes OD2
produced by producer1 and D2L produced by producer 2. When the total output becomes OR the price
will fall to OP1. As a result, producer 2 would earn profit equal to D2RNQ. The profit of producer 1 would
fall from OD2MP to OD2QP1.

Up �ll now the producers in the Edgeworth’s model have been behaving in the similar way as they behaved
in Cournot’s model. At this juncture and onwards the Chamberlin model would deviate.
The producers in the Chamberlin’s model learn and realize from the earlier experience about their
interdependence.

As a result of this awareness of mutual interdependence, producer 1 would decide to produce output OS
equal to output D2L of producer 2. The total output of both the producers is equal to monopoly output
OD2

When the aggregate output becomes OD2 the price level would rise to QP. In Chamberlin’s model the
Producer 2 is also aware of the mutual interdependency. Producer 2 also understands that the interests
of both the producers are best served when they produce half of monopoly output individually and hence
would retain its output at D2L.

Therefore, it can be observed that in Chamberlin’s model the duopolists realize their mutual
interdependence and behave intelligently. A stable equilibrium is ascertained in Chamberlin’s model
wherein the duopolists combine to produce monopoly output and charge monopoly price.

Chamberlin’s duopoly model is subjected to cri�cism even though it is an improvement over the other
classical models on Oligopoly. Cri�cs fail to appreciate the maximiza�on of joint profits without collusion
in Chamberlin’s model. Even in formal collusion there is an inherent tendency of collusion partners to
undercut each other’s prices.

5. Stackelberg’s Duopoly Model (With Diagram)

The Stackelberg model is a leadership model that allows the firm dominant to set its price first.
Subsequently, the follower firms op�mize their produc�on and cost. It was formulated by Heinrich Von
Stackelberg in 1934.
 • The Stackelberg model is a game theory model in economics that analyzes market compe��on
between firms.
• A�er a �me-lapse, the first two scenarios will result in an equilibrium condi�on where the profit
maximiza�on func�ons will serve as the determinants.
• In case 3, a warfare situa�on will occur as equilibrium will be challenging to establish. Therefore,
such a loggerhead stance can only be eliminated if a collision or failure of the weaker firm leads
to a monopoly in the market.
• Finally, in case 4, the profit maximiza�on expecta�ons will not hold, and they must revise.

It helps analyze compe��on between firms where the leader makes the decision while others follow. The
leader has beter access to technology, produc�on methods, cost, and a larger market. In certain sectors,
like telecom, automobiles, etc, there is always one dominant firm where this model is used.

The Stackelberg model of oligopoly remains an essen�al strategic model in economics. This model is
helpful to a firm when it realizes profitability
prospects under the first-mover advantage concept. A prac�cal instance where leaders commit to the first
move is capacity expansion. It is assumed that one cannot undo the ac�on.

In principle, Stackelberg’s strategy is essen�al, where the first mover, the leader, acts irrespec�ve of the
follower’s movement.

It makes decisions depending on the advantage that it has over its followers. The followers respond to it
a�er considering the market condi�ons and their own cost and benefit.

The advantage that the leader gets is in the form of beter technology and innova�on, a larger customer
base, lower cost of produc�on, etc. There is a sequen�al decision-making process which the leader makes,
and the followers follow.

The Stackelberg model of oligopoly is a useful tool in the oligopoly market and can be used to understand
the market dynamics and make future predic�ons.
Assump�ons
The Stackelberg model game theory follows certain assump�ons as men�oned in the list below:

• A duopolist can sufficiently recognize market compe��on based on the Cournot model.
• Each firm aims to maximize its profits based on the expecta�on that the decisions of its
compe�tors will not be affected by its output.
• It assumes perfect informa�on for all players in the market.
• Note: An underlying assump�on with the Cournot model is that the opera�ng firms cannot collude
and must seek to maximize profits based on their rivals’ decisions.
• The Stackelberg model follows a sequen�al move patern and is not simultaneous. We can say
that the leader who naturally has the first-mover advantage takes control of the output and hence,
price se�ng.
• Following the above argument, the Stackelberg leader firms have a smaller market share, and
profit margins

However, models such as Stackelberg, Cournot, and Bertrand have assump�ons that do not always hold
in real markets. While one firm may follow Stackelberg’s principles, the other might not. Thus, be crea�ng
a situa�on of complexity.

Calcula�ons
The following steps can help solve a basic problem based on the Stackelberg model game theory:

1. Write the demand func�on for the market.

2. Write the cost func�ons for both firms A and B in the market.
3. The individual reac�on func�ons in the duopoly are found by taking the par�al derivates of the
profit func�on.
4. Assume firm A as a leader, and obtain the profit maximiza�on equa�on for firm A, subs�tu�ng
firm B’s profit func�on in firm A equa�on.
5. Solve for firm B as being the follower.

Example:
Let us assume a market with three players – A, B, and C. If A is the dominant force, it will set the product’s
price first. A�er that, firms B and C will follow the price set and adjust their produc�on basis supply and
demand paterns accordingly. Thus, we see that the firm A has a Stackelberg model first mover advantage.
Possible Scenarios

The following circumstances are possible if two firms, A and B, par�cipate in a duopolis�c compe��on:
1. Firm A chooses to be the leader, and B wants to be the follower.
2. Firm B chooses to be the leader, and A wants to be the follower.
3. Both A and B want to be the leaders.
4. Both A and B choose to be followers.

Graph
An important genesis of this model is that one of the Stackelberg leaders produces more output than it
would have made under the Cournot equilibrium. Similarly, the follower in the Stackelberg model
s�mulates less produc�on than that in the Cournot model. To demonstrate stackelberg model first mover
advantage, look at the graphical representa�on below: –

Assuming the X-axis represents firm A’s produc�on and Y-axis for firm B’s output. Then, the quan��es Qc
and Qs indicate an equilibrium point for Cournot and Stackelberg condi�ons, respec�vely.

If firm A assumes itself as the Stackelberg leader and B as the follower, it will produce Qa’ quan�ty.
Consequently, firm B follows with Qb’, which is the best it can maximize up to. No�ce that Qs is the
Stackelberg equilibrium point where firm A produces more than it could create at Qc, the Courton
equilibrium point.

Similarly, when firm B follows a�er firm A has taken the output decision, it produces much less than it
could have in a Courton game.

Stackelberg Vs Other Models

The comparison of the Stackelberg model to the other models is given below:
The similarity to the Cournot Model

Both models assume quan�ty to be the basis of compe��on. Both models assume homogeneity of
products instead of the Bertrand model, including theory on differen�ated products.

Frequently Asked Ques�ons ( FAQs)

What is the Stackelberg model of oligopoly?
The made Stackelberg model of oligopoly is on the non-coopera�ve strategic game. First, a firm (leader)
determines how much to create in this model. Then, all the other firms (followers) conclude how much to
produce later.

What is the Stackelberg model of duopoly?

The Stackelberg duopoly model refers to the model that lets the dominant firm fix the price first. Later, the
follower firms enhance the cost and produc�on. Heinrich Von Stackelberg formed this model in 1934.

What is the difference between the Stackelberg model vs Cournot?

In the Stackelberg duopoly model, one firm is the leader and steps up first. The other firms then follow
the leader. In comparison, in a Cournot duopoly, firms ini�ate the move simultaneously.

What is the Stackelberg model in the supply chain?

The Stackelberg model in the supply chain is the model that is urged and prac�ced ge�ng an equilibrium
point where the members’ profit of the supply chain increases and opt the CSR level in the supply chain.
In this model, one must select the supplier as the leader and the manufacturer as the follower.

5.. Sweezy’s Kinked Demand Curve Model:

The kinked demand curve of oligopoly was developed by Paul M. Sweezy in 1939. Instead of laying
emphasis on price-output determina�on, the model explains the behavior of oligopolis�c organiza�ons.
The model advocates that the behavior of oligopolis�c organiza�ons remain stable when the price and
output are determined.

This implies that an oligopolis�c market is characterized by a certain degree of price rigidity or stability,
especially when there is a change in prices in downward direc�on. For example, if an organiza�on under
oligopoly reduces price of products, the compe�tor organiza�ons would also follow it and neutralize the
expected gain from the price reduc�on.

On the other hand, if the organiza�on increases the price, the compe�tor organiza�ons would also cut
down their prices. In such a case, the organiza�on that has raised its prices would lose some part of its
market share.
The kinked demand curve model seeks to explain the reason of price rigidity under oligopolis�c market
situa�ons. Therefore, to understand the kinked demand curve model, it is important to note the reac�ons
of rival organiza�ons on the price changes made by respec�ve oligopolis�c organiza�ons.

There can be two possible reac�ons of rival organiza�ons when there are changes in the price of a
par�cular oligopolis�c organiza�on. The rival organiza�ons would either follow price cuts, but not price
hikes or they may not follow changes in prices at all.
A kinked demand curve represents the behavior patern of oligopolis�c organiza�ons in which rival
organiza�ons lower down the prices to secure their market share, but restrict an increase in the prices.

Following are the assump�on of a kinked demand curve:

• Assumes that if one oligopolis�c organiza�on reduces the prices, then other organiza�ons would
also cut their prices
• Assumes that if one oligopolis�c organiza�on increases the prices, then other organiza�ons would
not follow increase in prices
• Assumes that there is always a prevailing price

A kinked demand curve model is explained with the help of Figure-2:

The slope of a kinked demand curve differs in different condi�ons, such as price increase and price
decrease. In this model, every organiza�on faces two demand curves. In case of high prices, an oligopolis�c
organiza�on faces highly elas�c demand curve, which is dd’ in Figure-2.

On the other hand, in case of low prices, the oligopolis�c organiza�on faces inelas�c demand curve, which
is DD’ (Figure-2). Suppose the prevailing price of a product is PQ, as shown in Figure-2. If one of the
oligopolis�c organiza�ons makes changes in its prices, then there can be three reac�ons of rival
organiza�ons.

Firstly, when the oligopolis�c organiza�on would increase its prices, its demand curve would shi� to dd’
from DD’. In such a case, consumers would switch to rivals, which would lead to fall in the sales of the
oligopolis�c organiza�on. In addi�on, the dP por�on of dd’ would be more elas�c, which lies above the
prevailing price.

On the other hand, if price falls, the rivals would also reduce their prices, thus, the sales of the oligopolis�c
organiza�on would be less. In such a case, the demand curve faced by the oligopolis�c organiza�on is PD’,
which lies below the prevailing price.

Secondly, rival organiza�ons will not react with respect to changes in the price of the oligopolis�c
organiza�on. In such a case, the oligopolis�c organiza�on would face DD’ demand curve.

Thirdly, the rival organiza�ons may follow price cut, but not price hike. If the oligopolis�c organiza�on
increases the price and rivals do not follow it, then consumers may switch to rivals. Thus, the rivals would
gain control over the market. Thus, the oligopolis�c organiza�on would be forced from dP demand curve
to DP demand curve, so that it can prevent losing its customers.

This would result in producing the kinked demand curve. On the other hand, if the oligopolis�c
organiza�on reduces the price, the rival organiza�ons would also reduce prices for securing their
customers. Here, the relevant demand curve is Pd’. The two parts of the demand curve are DP and Pd’,
which is DPd’ with a kink at point P.

Let us draw the MR curve of the oligopolis�c organiza�on. The MR curve would take the discon�nuous
shape, which is DXYC, where DX and YC correspond directly to DP and Pd’ segments of the kinked demand
curve. The equilibrium point is atained when MR = MC. In Figure-2, the MC curve intersects MR at point
Y where at output OQ.

At point Y, the organiza�on would achieve maximum profit. Now, if cost increases, the MC curve would
move upwards to MC. In such a case, the oligopolis�c organiza�on cannot increase the prices. This is
because if the organiza�on would increase the prices, the rival organiza�ons would decrease their prices
and gain the market share. Moreover, the profits would remain same between point X and Y. Thus, there
is no mo�va�on for increasing or decreasing prices. Therefore, price and output would remain stable.

However, kinked demand curve model is cri�cized by various economists.

Some of the major points of cri�cism are as follows:

• Lays emphasis on price rigidity but does not explain price itself.
• Assumes that rival organiza�ons only follow price decrease, which does not hold true empirically.
• Ignores non-price compe��on among organiza�ons. Non-price compe��on can be in terms of
product differen�a�on, adver�sing, and other tools used by organiza�ons to promote their sales.
• Ignores the applica�on of price leadership and cartels, which account for larger share of the
oligopolis�c market.

REFERENCES:
https://www.microeconomicsnotes.com/oligopoly-2/models-of-oligopoly/models-of-oligopoly-with-graphs-and-
criticisms/15959

https://www.economicsdiscussion.net/oligopoly/oligopoly-models-sweezys-kinked-demand-curve-model-and-
collusion-model/3781