in a kinked demand curve
Differing Objectives and Policies of Firms
1. Profit Maximisation (most common)
Firms aim to make the biggest profit: the difference between total revenue and total cost.
📈 Key rule: Produce where marginal revenue (MR) equals marginal cost (MC). In symbols: $MR = MC$.
2. Sales Maximisation
Firms want to sell the most units, even if it means lower profit per unit.
📉 Implication: They may set a lower price to increase demand, accepting a smaller margin.
3. Cost Minimisation
Firms try to keep costs as low as possible while keeping output constant.
🛠️ Example: Using cheaper raw materials or more efficient machinery.
4. Market Share Maximisation
Firms focus on gaining a larger share of the market rather than immediate profit.
🏆 Strategy: Lower prices, aggressive advertising, or product innovation.
5. Social Objectives
Some firms (e.g., cooperatives, NGOs) aim to maximise social welfare or community benefits.
🌍 Goal: Provide affordable goods, create jobs, or reduce environmental impact.
6. Kinked Demand Curve
The kinked demand curve explains why prices in some industries are sticky (hard to change).
🔄 Analogy: Think of a rubber band that snaps back when stretched too far.
Key Features
| Price Level | Elasticity of Demand | Firm’s Response |
|---|---|---|
| Above the kink | Highly elastic ($|ε|>1$) | Firms expect rivals to match price cuts → no price change. |
| Below the kink | Inelastic ($|ε|<1$) | Firms expect rivals not to follow price hikes → no price change. |
📌 Result: Prices tend to stay at the kink because firms avoid price wars.
Illustrative Example: Fast‑Food Chain
Imagine a burger chain that faces a kinked demand curve.
- If the chain lowers its price, competitors will also lower theirs → price war → profits fall.
- If the chain raises its price, competitors keep theirs unchanged → customers switch → sales drop.
- Therefore, the chain keeps its price steady, even if costs rise.
Exam Tips
- Draw a clear kinked demand curve: show the kink point and label elasticities.
- Explain why firms are reluctant to change price above or below the kink.
- Use the example of a fast‑food chain or a mobile phone manufacturer to illustrate.
- Remember: $MR$ is not constant on a kinked curve; it has a jump at the kink.
- Show that the equilibrium price is at the kink, where $MR = MC$ is satisfied.
- Use the term “price rigidity” and explain its relevance to the kinked demand model.
Revision
Log in to practice.