Kinked Demand Theory

The Kinked Demand Theory or the Kinked Demand Curve Theory is explained with respect to monopolistic competition and oligopoly. In fact, the development of the Kinked Demand Theory acted as a challenge to the Classical economic theories, especially the fast-changing prices, efficiency of the markets and the fundamental demand and supply models. On the whole, the Kinked Demand Curve Theory tries to explain sticky prices. In reality, the Kinked Demand Curves have ample resemblances with that of conventional demand curves in the sense that they both are downward-sloping in nature. The only distinction between the two curves is a hypothesized convex bend, with a discontinuity at the bend, known as the “Kink”. This means that the first undefined derivative at that specific point results into a jump discontinuity in the marginal revenue curve.

In the Classical Theory, any sort of change occurring in the structures of marginal revenue or marginal cost will instantly be evident in the price or the total quantity of a commodity sold. This will not be the case, had a “kink” existed here. It is mainly due to the jump discontinuity in the marginal revenue curve that the marginal costs could alter without bringing any change in the quantity or price of the commodity.

The graphical representation of the Kinked Demand Theory made by the famous economists, Hitch and Hall facilitate a better understanding of this economic concept. The hypothesis related to the preliminary setting of prices presented by Hall and Hitch explains the reason behind the presence of the ‘kink’ in the curve. It also indicates the exact location of ‘kink’ on the curve. The idea of ‘kink’ is based on the concept of “full cost”. Full cost is nothing but the marginal cost of every unit, with a percentage of the overhead or fixed cost and an extra profit-making percentage added to it. All these stress on the historical significance of traditional industries in deciding the initial price as per Hall and Hitch’s model.