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CFA Level I · CFA Level I Exam · The Firm and Market Structures

According to the kinked demand curve model of oligopoly, a firm believes that rivals will match its price cuts but ignore its price increases. The firm's marginal revenue curve most likely:

Marginal revenue has a vertical gap at the current output. Demand is more elastic above the kink and less elastic below it, which creates the discontinuity. Marginal cost can move within the gap without changing price or output, which explains why oligopoly prices tend to be sticky.

  1. Ahas a vertical gap at the current output, so costs can change without altering priceCorrect
  2. Bslopes upward at the current price, so output rises as price falls
  3. Cis horizontal at the current price, so the firm is a price taker

Explanation

Demand is elastic above the kink (rivals ignore increases) and less elastic below it (rivals match cuts), creating a discontinuity in marginal revenue. Marginal cost can shift within that gap without changing the profit-maximizing price and quantity, explaining price stability.

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