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IAI Actuarial Core Principles · Business Economics · Pricing strategies in the financial services sector

In an oligopolistic general insurance market, a kinked demand curve model is used to explain why premiums for motor cover stay stable. Which assumption underlies the kink?

The kink arises because rivals are assumed to match price cuts but ignore price rises. Demand is therefore elastic above the current price and inelastic below it, so firms gain little from changing premiums and prices stay stable.

  1. ARivals match a price cut but ignore a price riseCorrect
  2. BRivals ignore a price cut but match a price rise
  3. CRivals match both price cuts and price rises
  4. DRivals ignore both price cuts and price rises
  5. Rivals always collude formally on prices

Explanation

The kinked demand curve assumes that if a firm raises its price, rivals do not follow, so it loses many customers (elastic demand above the kink). If it cuts price, rivals match, so it gains little (inelastic demand below the kink). This discourages price changes. Option 1 reverses the assumptions.

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