Note on the Kinky Oligopoly Demand Curve

Abstract

In recent article' Professor George J. Stigler has discussed the theory of the kinky oligopoly demand curve and attempted to test empirically whether or not such curves really exist. His empirical evidence is divided into two parts: (1) histories of the prices quoted by the different firms in certain oligopolistic industries, intended to show whether it is valid assumption that businessmen expect their competitors to follow them on price cuts but not on increases, and (2) studies of the degree of price flexibility in 19 oligopolistic industries, intended to show whether the facts conform to certain conclusions regarding price rigidity which he holds are implied by kinky demand curve theory. I shall devote my attention primarily to part (1) of his empirical work. Here he inquires whether actual price behavior has corresponded to the pattern of expectations assumed by kinky demand theory: price increases are not followed by competitiors, but decreases are. He finds, in most cases, that both increases and decreases are nearly simultaneous, though some decreases may lag. Thus, in these industries, is little historical basis for firm to believe that price increases will not be matched by rivals and that price decreases will be matched.2 Attempts at empirical verification of the existence or nonexistence of the kinked demand curve are valuable, but in this case there has not been proper test of Sweezy's version of the theory. Moreover, as we shall see, the existence of entrepreneurial belief in kink is not incompatible with considerable amount of industry-wide price variation, which Stigler's empirical studies of prices by firms revealed as common. However, the complications that arise in applying the theory to groups of several firms suggest that it suffers from severe limitations as an analytical device. The direct approach to an inductive study of businessmen's expectations is to ask the businessman about them, along the lines indicated by George Katona.3 When R. L. Hall and C. J. Hitch did so, a majority of the entrepreneurs believed that price cuts would be matched and price increases would not be matched by rivals....4 It is not satisfactory substitute for such inquiries to assume that businessmen base their expectations on their experience and then take the observed historical price pattern of an industry as the measure of that experience. In the first place, business expectations are not always correct; they do not always correspond with reality. Second, even if we assume that expectations are pre-