Oligopoly prices are observably stickier than a cost curve alone would predict. Paul Sweezy in 1939, and Robert Hall and Charles Hitch in the same year, proposed the same explanation, and it rests on one asymmetric belief.
How does the kinked demand curve work?
A firm in a small group expects its rivals to respond asymmetrically. Raise price alone and nobody follows, so you lose customers fast: demand is elastic above the prevailing price. Cut price and everybody matches to protect share, so you gain far fewer customers than you expected: demand is much less elastic below it. The firm's own demand curve is therefore two segments joined at the prevailing price, with a kink at the current point.
The consequence is not in the demand curve. It is in marginal revenue.
For a linear demand P = a − bq, marginal revenue is MR = a − 2bq, a line with twice the slope. Two demand segments with different slopes therefore produce two marginal-revenue lines with different slopes, and at the kink quantity they do not meet. There is a vertical gap in the marginal-revenue schedule directly under the kink, and its height is set by the difference between the two slopes.
Advertisement
Why does the price stay put?
Profit maximisation requires marginal cost to equal marginal revenue. If the marginal cost curve passes anywhere through that vertical gap, the profit-maximising quantity is the kink quantity, whatever the exact level of marginal cost. Cost can rise, cost can fall, and as long as the new marginal cost is still inside the gap, the optimal price does not change by a single unit.
Worked Example 5 computes the gap for a synthetic Indian cable maker: marginal revenue falls from ₹280 to ₹40 per metre at the kink, so marginal cost can sit anywhere in a seven-fold range and the price stays at ₹400. The firm's earnings move a great deal inside that range, which is the point analysts miss most often. Contribution falls from ₹1.50 crore a month to ₹0.84 crore a month with the price and the volume both frozen.
A price that does not move is not evidence that nothing happened.
What are the limits of the model?
Two honest limits, because this model is easy to over-apply. It explains why an existing price is sticky and says nothing about how the price got there, which is a real gap rather than a quibble: the model has no equilibrium of its own. And the empirical evidence for the asymmetric-response assumption is weak. George Stigler tested it in 1947 across seven American oligopolies and found rivals did not behave as the model requires, and the finding has never been decisively overturned.
Use the kinked demand curve to explain an observed rigidity, never to predict that one will occur.