Paul Sweezy's Kinked Demand Curve

[bailey_187]

http://www.amosweb.com/images/MsOp41c.gif

This is a demand curve for an Oligopoly.
I get the fact that if the firm raises its price, Q will move to the left more than the price increase because other firms will undercut it right?
And if the price is lowered, the increase in Quantity will only be minimal as the other oligopolists will match it?
But i dont get what the Marginal Revenue curve does?
Also, is the firm always at QandP i.e. that an increase in price will be elastic and a decrease in price inelastic?

And if there are any critcisms of this firm, please do tell me

[black_tambourine]

Marginal revenue represents how much additional revenue will be brought into the firm by selling one additional good. Using the rule of thumb that prices decrease as quantity produced increases, all other things being equal, we can calculate the marginal revenue by subtracting the product of the previous price/quantity coordinate from the current price/quantity coordinate that represents one more unit produced. For example, let's say you can either produce 100 units of a commodity and sell them for $5 each, or produce 101 units while selling them at 4.99 each. (101 * 4.99) - (100 * 5). In this case, the revenue for selling one more good would be 3.99. Note that the marginal revenue can be negative, which means your firm is actually losing money for each additional good sold.

Sweezy's discontinuity in the marginal revenue curve is a result of the fact that, as you already know, the increase in quantity of goods sold will "stall" after prices go below a certain level in oligopolistic competition - this is the "kink" in the previously smooth curve. In other words, whereas previously there had been a certain proportionality between price and quantity, quantity now increases at a far slower rate than price decreases, at least as long as you're still within the range of prices that are feasible for turning a profit. The result is in order to achieve the same rate in the increase of quantity sold, you would have to lower prices such that the marginal revenue would drop precipitously from its previous level, possibly below your firm's marginal costs (i.e. the cost of producing one more unit), and even into the negative. Hence a major disincentive toward lowering prices, as well as raising them. The revenue curve does resumes a relatively stable course, as you can see, after this drop - but by then, you're already screwed, as its grade is steeper than poreviously and your prices are probably too low to turn a profit at this point.

To illustrate: Take the previous example of 101 goods at 4.99. Assume the oligopolistic competition is such that one additional good will only be sold if the per-unit price is reduced to 4.89: you only had to reduce the price by .01 to sell 1 good above 100, but now must reduce it by .10 to sell 1 good over 102. If you calculate the marginal revenue for this, it has gone from 3.99 to -1.22 - a drop of 5.21 and a net loss for your firm.

As for P and Q, Sweezy qualified that with a high level of effective demand, one could see a moderation of this trend - prices would become less upwardly elastic, since wages and costs of production are likely higher in such a period, and conversely they would also become less downwardly inelastic, since most firms are probably doing well enough in sales that they do not immediately have to match any price cut by a competing firm.

In a recession, of course, the tendencies will be exacerbated rather than moderated, and prices will tend to be even more immobile from the graph's fixed point. This calls into question the "mainstream" idea that prices will fall during an economic downturn.

I haven't finished slogging through the criticisms of this model yet, so I can't comment on them.

[bailey_187]

thanks

I dont get why the MR curve is such a strange shape though?

[black_tambourine]

Yeah, I forgot to mention that originally but I've edited my post to put the details in. Basically, after this precipitous drop the revenue curve becomes relatively stable again (albeit with a steeper downward grade), since your prices are so low that other firms wouldn't think of matching them (they'd go bankrupt, as you likely are about to).