Kinked Demand Curve Model or Sweezy Model:
The Kinked Demand Curve Model was proposed by Paul Sweezy in 1939. It primarily helps
explain price rigidity in an oligopoly market—why prices often do not increase or decrease.
Assumptions of the model:
1. Few firms (oligopoly)
2. Firms sell close substitutes
3. No advertisement cost
4. If a firm lowers its price, others will follow
5. If a firm increases its price, others will not follow
Kinked Demand Curve model and price Rigidity :
In the diagram, the kink (bend) happens at point E, where the price is OP and quantity is OQ.
If a firm increases the price, other firms do not follow, so its sales go down. This part of the
curve (dE) is called elastic.
If a firm lowers the price, other firms also lower theirs, so sales do not rise much. This part (ED)
is called inelastic.
That’s why firms don’t want to change the price.
Criticism of the model:
1. It does not explain where the initial price comes from
2. In reality, price rigidity is not always observed
3. The model doesn’t work in inflationary situations
4. It does not explain non-price competition (like aassumptions)
5. Actual firm behavior often does not match the assumptions
It is one of the most popular models for explaining price rigidity
Welfare Economics ( Easy Words)
Welfare Economics is a part of economics that looks at how people in a society are doing. It
checks if economic decisions are helping people live better. The goal is to make sure everyone
gets a fair and happy life.
Main Points (Simple English)
1. Social Welfare: It means the well-being or happiness of people, not just money.
2. Market Types: It looks at how different markets (like competition or monopoly) affect people.
3. Government Help: It sees how the government can fix problems and help people.
4. Fairness: It thinks about what is fair, equal, and good for all.
5. Main Goal: To make life better for as many people as possible.
Assumptions (Easy Points)
1. People’s well-being can be measured.
2. More benefits = better life.
3. People act to get the best for themselves.
4. People’s choices stay the same.
5. Total social welfare = adding up everyone’s well-being.
Cournot’s Duopoly Model (Simple Explanation)
Introduced by: Augustine Cournot, a French economist, in 1838.
This is one of the earliest models of oligopoly (few sellers) where firms do not cooperate with
each other.
Assumptions:
1. There are two firms (duopoly market)
2. Both produce homogeneous product (same product – e.g., mineral water)
3. Cost of production = zero
4. Large number of buyers in the market
5. Firms know the market demand curve, which is linear and downward sloping
6. Each firm assumes the rival’s output will remain fixed
7. Each firm chooses its own output (not price) to maximize profit
8. Price is set by market, not by individual firms
Explanation of the Model
There are two firms: Firm X (Fx) and Firm Y (Fy).
They both sell mineral water in the same market.
The total demand in the market is shown by the line AB.
The total amount people want to buy is OB.
If both firms try to sell the full amount, price will fall to zero. That means no profit. So they will
not do that.
First, Firm X (Fx) starts. It wants to make the most profit, so it produces OJ amount of water,
where its cost = revenue (MC = MR).
→ So, Fx fixes its output at OJ.
Now Firm Y (Fy) sees this and thinks, “I will produce from the part that Fx did not produce.”
→ So, Fy produces JK, which is half of the leftover demand, and sells it at price OP1.
That means Fy makes ¼ of the total market.
Fx sees this and reacts. Now it thinks:
“Fy will keep producing JK, so I will now produce half of the rest.”
→ That means Fx produces ½ × (1 – ¼) = ⅜ of the market.
Then Fy again reacts and produces ½ of what is left, which is ½ × (1 – ⅜) = 5/16.
This kind of action and reaction goes on, because both firms are naive (they don’t learn from
past).
After some time, both firms produce ⅓ of the market.
Together, they supply 2/3 of the total demand.
But still, they don’t make the highest possible profit because they don’t work together.
If they worked together like a monopoly:
They would produce ½ of the total market,
Charge a higher price (let’s say price P),
And each firm would make ¼ of the output.
That way, total profit would be more.
Assumptions:
1. There are two firms in the market.
2. Both produce homogeneous products (same type, e.g., mineral water).
3. Production cost is zero.
4. Many buyers in the market.
5. Each firm knows the market demand, which is a downward-sloping line.
6. Each firm believes the rival will keep output fixed.
7. Each firm wants to maximize its own profit.
8. Price is not fixed by firms – they sell at the market price.
9. Firms behave naively – they don’t learn from past mistakes.
Bertrand’s Duopoly Model
“Bertrand’s Duopoly Model was proposed by Joseph Bertrand in 1883 as a criticism of the
Cournot model. The main idea in this model is price competition, meaning that the two firms try
to undercut each other’s prices to attract customers.”
Assumptions:
1. There are two firms
2. Firms produce identical products.
3. Firms have identical cosfixed
4.Each firm assumes the competitor’s price remains fixed
5.5. Unlimited production capacity
Equilibrium in Bertrand Model (with Reaction Curves):
In the Bertrand model, each firm reacts to the price set by the other. This is shown with two
reaction curves:
RA = Reaction curve of Firm A (on X-axis)
RB = Reaction curve of Firm B (on Y-axis)
Let’s say:
1. Firm A sets price PA₁
2. Firm B sets price PB₁, thinking A won’t change
3. But Firm A reacts and lowers the price to PA₂
4. Then Firm B reacts again and sets PB₂
This price-cutting continues like a battle, until neither firm wants to change its price.
At this point, both reaction curves intersect at point ‘e’, which is the equilibrium.
If production cost is not zero, the equilibrium price will stop above marginal cost, not at zero.
Assumptions:
1. Firms do not learn from past mistakes
2. Though high profits are possible, the price war reduces them
3. There is a possibility of tacit collusion
4. In reality, firms often face production capacity constraints
5. When both firms charge the same price, it is unclear who sells how much
