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

In an oligopolistic market for retail health insurance, the kinked demand curve model is used to explain why premiums tend to be stable. Which statement correctly gives the reasoning behind the kink?

The kink arises because rivals ignore a price rise but match a price cut. Demand is therefore elastic above the current price and inelastic below it, creating a gap in marginal revenue, so prices stay stable despite moderate cost changes.

  1. ARivals match a price rise but ignore a price cut, so demand is elastic below the current price and inelastic above it
  2. BRivals ignore a price rise but match a price cut, so demand is elastic above the current price and inelastic below itCorrect
  3. CRivals match both rises and cuts, so demand is perfectly elastic at the current price
  4. DRivals ignore both rises and cuts, so demand is perfectly inelastic
  5. Firms collude openly, so demand is a horizontal line at the cartel price

Explanation

The model assumes that if a firm raises its price rivals do not follow, so it loses many customers (elastic demand above the current price). If it cuts price rivals match, so it gains little (inelastic below). The marginal revenue curve then has a gap, so costs can change without prices moving. Option 0 reverses the assumption.

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