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CA Foundation · Business Economics · Price Determination in Different Markets

In the kinked demand curve model of oligopoly, the demand curve above the prevailing price is relatively elastic and the part below it is relatively inelastic. Which of the following correctly explains this shape?

The kinked demand curve arises because rivals match a price cut but ignore a price rise. A firm raising price loses many customers, making demand elastic above the kink. A firm cutting price gains little, making demand inelastic below the kink.

  1. ARivals match a price cut but ignore a price riseCorrect
  2. BRivals match a price rise but ignore a price cut
  3. CRivals match both price rises and price cuts
  4. DRivals ignore both price rises and price cuts

Explanation

If a firm raises its price, rivals do not follow, so it loses many customers and demand above the kink is elastic. If it cuts its price, rivals match the cut, so it gains few customers and demand below the kink is inelastic. The option saying rivals match rises but ignore cuts reverses this logic.

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