Explain Sweezy's kinked demand curve model? Why does the demand curve have a kink?

An oligopoly is a market structure where a few large firms dominate the industry, each with significant control over pricing and market conditions. Unlike perfect competition or monopoly, where many firms or a single entity hold sway, an oligopoly occupies a middle ground, combining traits from both competitive and monopolistic markets. Firms within an oligopoly are well aware of their interdependence, acknowledging that the actions of one firm can substantially impact the others. This mutual awareness often leads to strategic behavior.

Because there are only a few competitors, each with a sizable market share, their strategies, especially regarding pricing and output, can vary widely compared to other market forms. Oligopolistic competition can manifest in various ways, such as through price wars, collusion, product differentiation, and advertising.

Price rigidity refers to the phenomenon where prices remain stable and do not adjust quickly to changes in supply or demand. This is particularly noticeable in oligopolistic markets, where firms prefer to maintain current prices rather than adjusting them in response to market pressures. Several factors contribute to this rigidity, including the potential for price wars that can erode profits, the existence of implicit or explicit agreements among firms, and the fear of setting off a negative chain reaction with competitors.

Price rigidity means that even when costs rise or fall, or when demand fluctuates, oligopolistic firms might choose to absorb changes in profit margins to maintain their pricing strategies and the status quo. This stability offers predictability for both firms and consumers, but it can result in inefficiencies within the market.

A non-collusive oligopoly is an oligopolistic market where firms act independently and competition exists without explicit agreements between firms to fix prices or output levels. Unlike their collusive counterparts, where firms might engage in activities like cartels or price-fixing, non-collusive oligopolists do not coordinate their strategies.

Non-collusive firms often engage in competition through means other than price, like marketing and product innovation, due to the perceived repercussions of price alterations. While collusion might bring higher collective profits, non-collusive behaviour can lead to more dynamic markets and greater consumer benefits due to the innovation and competitive actions it incentivizes.

Asymmetric reactions in the context of oligopoly refer to the unequal response of firms to the pricing decisions of their competitors. This concept is a cornerstone of the Sweezy's kinked demand curve model, which posits that firms will react differently to a price increase than they would to a price decrease by a competitor.

When a firm lowers its prices, other firms in the oligopoly are likely to follow in order to maintain their market share, leading to a potentially harmful price war. Conversely, when a firm raises its prices, competitors are less likely to match these higher prices as they can benefit from gaining a larger share of price-sensitive customers. This imbalance in reactions leads to a kinked demand curve, manifesting the reluctancy of oligopolists to alter prices and thus contributing to overall price rigidity in the market.

Implications of Asymmetric Reactions

Understanding asymmetric reactions helps economists and businesses predict market behaviors in oligopolies, aiding in strategizing and policy-making to ensure competitive yet stable market conditions.