Final answer:
The kinked demand curve is a situation in oligopolies where firms agree to match competitors' price cuts but not price increases, leading to a price and quantity equilibrium that creates a 'kink' in the demand curve.
Step-by-step explanation:
The concept of kinked demand refers to a situation in an oligopoly market structure where firms commit to match price cuts by competitors but not price increases. This behavior results in a demand curve with a distinct kink. For example, consider an oligopoly airline that is part of a cartel, agreeing to provide 10,000 seats on a specific route at a price of $500. If this airline attempts to reduce its price to sell more, other cartel members will immediately match the price cut, leading to minimal gains in quantity sold, thus defining the 'kink' in the demand curve at the agreed price and quantity. Conversely, if the airline tries to raise its price, others will not follow, which can lead to a significant drop in quantity sold.
The kinked demand curve plays a disciplinary role among cartel members, encouraging them to adhere to pre-agreed output and pricing levels through a strategy of matching price decreases but not increases. This arrangement helps stabilize the market and maintain agreed-upon prices and quantities within the oligopoly.