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CMA Foundation · Fundamentals of Business Economics and Management · Forms of Market

According to the kinked demand curve model of oligopoly, why do prices tend to remain rigid around the prevailing price?

Prices stay rigid because rivals are assumed to ignore a price increase but match a price cut. A firm raising price loses many customers, while a cut brings little gain since competitors follow, so demand is elastic above the kink and inelastic below it.

  1. ARivals match a price increase but ignore a price cut
  2. BRivals ignore a price increase but match a price cutCorrect
  3. CRivals ignore both price increases and price cuts
  4. DRivals match both price increases and price cuts

Explanation

If a firm raises its price, rivals do not follow and it loses many customers, so demand above the kink is elastic. If it cuts its price, rivals match, so the firm gains little and demand below the kink is inelastic. Hence no firm gains by changing price. Option A reverses this behaviour.

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