The Kinked Demand Curve with a Conjectural Hitch – A Micro Extension with Macro Implications

Michael Bradfield ()
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Michael Bradfield: Department of Economics, Dalhousie University

Working Papers from Dalhousie University, Department of Economics

Abstract: Textbooks present the kinked demand curve model as an interesting but largely irrelevant explanation for oligopoly markets with stable prices. This follows Stigler’s misrepresentation of Sweezy’s article. Yet the original articles suggested that the kinked demand curve might also explain price instability and apparently perverse business decisions. This paper uses an extension of the kinked demand curve, the “conjectural hitch,” which recognizes that a firm may feel that new market conditions require a change in behaviour to protect profits. Firms may raise prices because of falling demand. If a significant number of industries behave this way, stagflation and even job- less recovery will be generated in the economy at large. On the cost side, the conjectural hitch can explain why firms raise prices when fixed costs increase, for instance, when interest rates rise.

Pages: 22 pages
Date: 2007-04-01
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