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The lower segment ED1 of the demand curve is steeper. Even with a significant fall in price from P to P1 increase in the quantity demanded QQ1 is very small. Reduction in price will then result in a smaller total revenue for the firm. On the other hand, any attempt to cause a small rise in price as PP2 on the flatter portion ED of the demand curve causes a significant fall in the quantity demanded from Q to Q2. This again will cause total revenue of the oligopolist to be smaller at higher price. The oligopolist is rigidly fixed at E, the point of Kink with P as the price. This therefore is also called sticky price solution.

Oligopoly analysis (such as the above) has been carried out exclusively in terms of demand or average revenue curve. So long as oligopolists find the average revenue higher than the average cost of producing equilibrium output, they will make profits. Any reference to the marginal cost of a firm is not necessary in such an analysis. Therefore it is also called Full Cost (not marginal cost) Oligopoly Equilibrium Solution. Even if we desire to bring in the marginal revenue and the marginal cost curves into the discussion that does not alter the equilibrium attainment of the firm. This can be seen in Figure 47.

We have two marginal revenue curves MR and MR1 corresponding to the average revenue curve segments DE and ED1 respectively. The two marginal revenue curves are broken and the broken portion is along the vertical line EQ. Marginal cost curve of the firm passes from the broken portion of the marginal revenue curve. The equality between MR=MC is also fulfilled for the same output level Q and price P. The Kinked demand curve appears to be satisfactory in every respect.

However, the Kinked demand curve solution has also come under some criticism. Sweezy's behavioral assumptions are doubted. Once the Kink position is known the rest of the analysis follows; however, how to determine the Kink is not stated.

Index

12.1 Oligopoly
12.2 Cartel

Chapter 13

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