According to this theory, the equilibrium of the oligopolistic firm is defined by the point of kink. Thus K, the firm will produce OQ quantity of output and sell it at the price OP. the firms marginal cost curve MC passes through the gap EF in the marginal revenue curve. For any level of output less than OQ, the MR is more than MC and therefore profits can be made on additional units of output level OQ. But beyond the output level OQ, for any additional output, marginal cost is higher than marginal revenue as the portion of marginal revenue curve FG lies below the MC curve. Thus any level of output above OQ would bring losses on additional output. Hence, total profits are maximized at the level of output OQ that corresponds to the point of kink.
However, this equilibrium is not defined in terms of the conventional criteria of the point of intersection of MR curve is passing through a discontinuous part of MR curve through the gap in MR. the discontinuity of MR curve implies that there is a range within which costs may change without affecting the equilibrium price OP and equilibrium output OQ. Thus, even when the MC curve shifts upwards or downwards, but remains within this gap, price and output are not affected. Even when the marginal coast curve shifts upwards from MC to MC’ and MC”, or shifts downwards from MC” to MC’ and MC, price and output do not change and the firm still maximizes profits by producing OQ amount and selling it at OP price.
The Kinked Demand Curve hypothesis appears to provide a determinate solution to the pricing under oligopoly. The behaviour pattern depicted by the kink demand model seems to be quite realistic in this highly competitive business market dominated by keenly competing oligopolistic firms. it rightly explains the phenomenon of price rigidity as no one will raise prices for the fear of losing his sales to the rivals, nor will price be reduced because the firm doing so will not get much out of the price reduction.
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