Kinked Demand Curve: Introduction

In this lesson we’ll see how oligopolistic firms can be modelled using the kinked demand curve diagram:

Let’s break it down…

Take an oligopolistic market, like the:

Take an oligopolistic market, like the fizzy drinks market. 

We’ll sketch our kinked demand diagram for Coke. [flash the full diagram, then return to just the plain axes]

Coke charges 50p for a fizzy drink can…and rival firms like Pepsi and others also charge 50p.

But if Coke puts its price above 50p to 60p, it will suddenly lose a tonne of customers because:

If Coke puts its price above 50p to 60p, it will suddenly lose a tonne of customers, because they’ll just switch over to now cheaper Pepsi.

So above 50p, Coke’s demand is elastic because of substitutes like Pepsi.

If Coke puts its price up above 50p, consumers will immediately switch over to cheaper substitutes, and Coke’s quantity demanded will decrease big time.

But what if, instead, Coke put its price below 50p, down to 40p?

If Coke put its price below 50p down to 40p, Coke would expect to attract a lot more customers because they would now be cheaper than Pepsi. 

But Pepsi wouldn’t be happy about this, because they’ll lose customers to the now cheaper Coke. 

So competitor Pepsi would also cut their price to 40p to match Coke and keep their customers. 

So, actually, Coke wouldn’t see much of an increase in sales at all 🙁

So below 50p, demand for Coke is

So below 50p, demand is inelastic because when Coke tries to decrease its price, Pepsi will do the same, and Coke won’t gain many new customers at all.

And above 50p demand is,

And above 50p demand is elastic because of substitutes: if Coke charges more than 50p, it’ll lose lots of customers because they’ll switch over to cheaper Pepsi.

So Coke’s demand or AR curve looks like this, kinked:

Above 50p, demand or AR1 is elastic (flatter). 

Below 50p, demand or AR2 is inelastic (steeper). 

And that’s it for Part 1, we’ll finish off the kinked demand curve in part 2.