13A
Two Alternative
Theories of Pricing
Behavior
Previously…
• Oligopoly
– A market structure in which there are a small number
of firms
– Firms interact strategically
– Can be competitive or collusive
• Game theory helps determine when cooperation
among oligopolists is most likely
– In many cases, cooperation fails to materialize
because decision-makers have dominant strategies
that lead them to be uncooperative.
Two Alternate Theories
• Two alternative theories argue that oligopolists
will form long-lasting cartels.
– Kinked demand curve
– Price leadership
The Kinked Demand Curve
• Kinked Demand Curve Theory
– A group of oligopolists has established an output level
and price
– Firms will mostly ignore a rival’s price increases
• Firms hold their prices steady to capture rival’s customers
who don’t want to pay more
• Rival who raised price will see a big sales decrease
– Firms have a greater tendency to respond
aggressively to a rival’s price cuts
• A price decrease by a rival will be matched by competitors
• No one firm is able to pick up very many new customers
The Kinked Demand Curve
Price Leadership
• Kinked Demand Theory
– Doesn’t explain price changes
• Price leadership
– A dominant firm sets the price that maximizes profits
and the smaller firms follow
– Explains price changes
– Not illegal since it does not involve explicit collusion
– Involves tacit collusion where there is an
understanding among firms that attempts to fight the
changes made by the leader that will lead to lower
profits for everyone
Price Leadership
• Example: airlines
– Leader airline sets the
fare for a given route,
and others follow
– Each firm knows that
lowering the price will
hurt everyone, so the
price stays where it
was set by the leader