In 1939 Paul Sweezy of Harvard University wrote his paper ‘Demand Under Conditions of Oligopoly’ in which he explained conditions around the kinked demand curve. He suggest that rivals in a market react differently according to whether a price change is upward or downward.
If producer A raises his price, his rival producer B will acquire new customers. However if producer A lowers his price, his rival producer B will lose new customers. From the point of view of any particular producer this means simply that if he raises his price he must expect to lose business to his rivals (his demand curve tens to be elastic going up), while if he cuts price he has no means to believe he will succeed in taking business away from his rivals (his demand curve tends to be inelastic going down). In other words, the imagined demand curve has a “corner’ at the current price.
MR curve at 0 output
An important point to note with a kinked demand curve is that as revenue falls if the price increases or decreases the MR curve must cut the horizontal axis at this output. Therefore, as well as being where MC=MR profit maximisation output it is also revenue maximisation. If a seller reduces the price of the product below P1, his rivals will also reduce their prices. Though he will increase his sales, his revenue would be less than before. The reason is that the AR portion of the kinked demand curve below P is inelastic and the corresponding part of marginal revenue curve after Q1 is negative. Thus in both the price-raising and price-reducing situations, the seller will be a loser. He would stick to the prevailing market price P1 which remains rigid.
A lot of textbooks draw the second part of the MR above the horizontal axis which indicates that total revenue is still increasing.
For more on the Kinked Demand Curve view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.