Q.Explain the kinked demand curve theory of oligopoly. How does it help explain price rigidity?

The kinked demand curve theory assumes rivals ignore a price rise but match a price cut, which bends a firm's demand curve at the current price and helps explain why oligopoly prices often stay unchanged. …

Under oligopoly, firms are mutually interdependent — before changing its own price, a firm must consider how its rivals will react. Paul Sweezy's kinked demand curve theory builds a simple but powerful model of this interdependence around two specific (asymmetric) assumptions about how rivals react:

• If a firm raises its price above the current level, rivals are assumed not to follow — they are happy to keep their own prices unchanged and gain the customers the price-raising firm loses. So for price rises, the firm's demand is relatively elastic — it loses a large share of sales.
• If a firm cuts its price below the current level, rivals are assumed to match the cut immediately, to avoid losing their own market share. So for price cuts, the firm's demand is relatively inelastic — it gains very little extra sales, because rivals cut their prices too.

This asymmetry means the firm's demand curve is comparatively flat above the current price and comparatively steep below it — a kink exactly at the price currently being charged. This kink in the demand (AR) curve produces a discontinuity (vertical gap) in the corresponding marginal-revenue curve at the same output level. …

Students often forget the asymmetry is directional — it is specifically 'rivals match cuts but ignore rises', not the reverse; getting the direc …