Business Economics · Price Determination in Different Markets

Oligopoly and Kinked Demand Curve: CA Foundation Business Economics

Updated 1 October 2026

Oligopoly is a market with a few large sellers whose decisions depend on each other. The kinked demand curve explains price rigidity: rivals match a price cut but ignore a price rise, so demand is elastic above the kink, inelastic below it, and MR has a gap where costs can change without changing price.

Understand Oligopoly and Kinked Demand Curve

Oligopoly is a market structure where a few big firms dominate. Think of cars, telecom, cement or airlines. Each firm is large enough that its actions affect the others.

The key feature is interdependence. Before changing price or output, a firm must guess how rivals will react. Under perfect competition and monopoly this problem does not arise. Other features: barriers to entry, products that may be identical (pure oligopoly) or differentiated (differentiated oligopoly), heavy advertising and non-price competition, and no single agreed model of behaviour.

Firms can behave in two ways. In collusive oligopoly, firms cooperate, either openly (a cartel) or tacitly (price leadership), to fix price or share the market and act like a joint monopoly. In non-collusive oligopoly, firms compete independently and each guesses rivals' reactions. The kinked demand curve belongs here.

The kinked demand curve (Sweezy model) explains why prices stay stable. Suppose the market price is P. If a firm raises its price, rivals do not follow, so it loses many customers. Demand above P is highly elastic. If it cuts its price, rivals match the cut, so it gains few customers. Demand below P is less elastic. The demand curve therefore bends (kinks) at the current price.

The kink makes the marginal revenue (MR) curve discontinuous. There is a vertical gap in MR at the output of the kink. If marginal cost moves up or down within that gap, the profit-maximising price and output do not change. This is why prices are rigid. A limit of the model: it explains why price stays put, but not how the original price was set.

Key formulas to remember

Kink condition: Above the kink: elastic demand (rivals do not follow). Below the kink: less elastic demand (rivals follow).; Remember: rivals ignore a rise and match a cut.
Equilibrium in kinked demand model: MC cuts MR within the vertical gap of the MR curve, so price and output stay unchanged; Price changes only if MC moves outside the gap, or demand shifts.
Profit-maximising rule: MR = MC (with MC rising through MR); Applies here too, but the MR gap makes the equilibrium stable.

How to solve Oligopoly and Kinked Demand Curve questions

Use this method for any oligopoly or kinked demand question.

1Read the clue words: 'few sellers', 'interdependence', 'rivals react', 'price rigidity', 'cartel', 'price leader'.
2Decide whether the question is about features, collusive vs non-collusive behaviour, or the kinked curve.
3For collusion questions, check whether firms cooperate (cartel, price leadership) or act independently.
4For kinked curve questions, apply the rule: rise is not followed, cut is matched.
5Link that to elasticity: elastic above the kink, less elastic below it.
6If cost changes, check whether MC stays within the MR gap. If yes, price is unchanged.
7Eliminate options that mention perfect competition traits, such as free entry or a single price taker, or a smooth MR curve.

Quickest way: Three-cue shortcut for oligopoly MCQs

When to use it: Use for most one-line theory MCQs where you must pick the right statement quickly.

Cue 1: 'few firms' plus 'interdependence' means oligopoly.
Cue 2: 'price stability' or 'rigid price' means kinked demand curve.
Cue 3: 'agreement' or 'cartel' means collusive; 'independent decisions' means non-collusive.
Remember the pair: rise ignored, cut matched.
Reject any option saying rivals match a price rise or ignore a price cut.
Skip long wording traps quickly; with 0.25 negative marking, guess only after removing two options.

Common mistakes in Oligopoly and Kinked Demand Curve

Saying rivals match a price rise in the kinked model.
Students reverse the reaction pattern.
Fix: Rivals ignore a price rise because they gain customers when the firm loses them. They match a cut to avoid losing market share.
Thinking the kinked demand model explains how the price is first set.
The model is taught as a pricing theory.
Fix: It only explains why an existing price tends to stay stable.
Treating collusion and cartel as different things.
Terms are used loosely.
Fix: A cartel is a formal type of collusive oligopoly. Price leadership is a tacit type.
Placing the elastic part below the kink.
Students confuse which segment is flatter.
Fix: The upper segment is flatter and more elastic. The lower segment is steeper and less elastic.
Saying price never changes under oligopoly.
Overstating price rigidity.
Fix: Price is sticky only within the MR gap. Large cost or demand changes can move it.

Worked examples

Example 1

Under the kinked demand curve model, if an oligopolist raises price above the current level, rivals are assumed to: (a) match the rise fully (b) ignore the rise (c) exit the market (d) form a merger immediately

Show the solution

Recall the model's assumption about reactions.
Rivals want to gain customers, so they do not follow a price rise.
This makes demand above the kink highly elastic.
Option (a) is the reaction to a price cut, not a rise; (c) and (d) are not part of the model.

Answer: (b) ignore the rise

Example 2

The MR curve of a firm facing a kinked demand curve has a vertical gap. If marginal cost rises but still passes through this gap, the firm will: (a) raise price and cut output (b) cut price and raise output (c) leave price and output unchanged (d) shut down

Show the solution

MC cuts through the vertical gap in MR, so it never meets the MR curve at a point. Instead, it crosses the gap.
In the gap, MR jumps from higher to lower at the kink output.
So MR ≥ MC to the left of the kink output and MR ≤ MC to the right of it.
Profit is therefore maximised at the kink output, with the same price.

Answer: (c) leave price and output unchanged

Example 3

Which of the following is a feature of collusive oligopoly? (a) Firms decide price independently and secretly (b) Firms agree on price or output, as in a cartel (c) Free entry of new firms (d) Each firm is a price taker

Show the solution

Collusive means firms cooperate rather than compete.
Agreement on price or output is the cartel form.
Independent decisions describe non-collusive oligopoly, so (a) is wrong.
Free entry and price taking belong to perfect competition, so (c) and (d) are wrong.

Answer: (b) Firms agree on price or output, as in a cartel

Exam tips

Questions are mostly direct theory MCQs. Learn the reaction rule (rise ignored, cut matched) cold.
Expect statement-type questions on features: few sellers, interdependence, entry barriers, advertising.
Know that the kinked demand curve explains price rigidity, not price formation.
Be ready to pick the odd one out between cartel, price leadership and independent rivalry.
If two options look close, check for words like 'always' or 'never' and treat them with caution.

Practice questions from Price Determination in Different Markets

Oligopoly and Kinked Demand Curve: frequently asked questions

Why are prices rigid under oligopoly?

Each firm fears rivals' reactions. A price rise loses customers because rivals do not follow, and a price cut starts a price war because rivals match it. So firms avoid changing price.

What is the difference between collusive and non-collusive oligopoly?

In collusive oligopoly, firms cooperate through a cartel or price leadership to fix price or output. In non-collusive oligopoly, firms act independently and guess rivals' reactions, as in the kinked demand model.

What are the main features of oligopoly?

A few large sellers, interdependence of decisions, barriers to entry, and heavy use of advertising and other non-price competition. Products may be identical or differentiated.

Why is there a gap in the MR curve in the kinked demand model?

The two segments of the demand curve have different elasticities, so each has its own MR curve. At the kink output, MR jumps from one to the other, creating a vertical gap.