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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 below it is relatively inelastic. Which assumption about rivals' behaviour explains this shape?

The kinked shape arises because rivals ignore a price increase but match a price cut. A firm raising price loses many customers to rivals, so demand is elastic above the kink, while a price cut is copied, so demand is inelastic below it.

  1. ARivals match both price increases and price cuts
  2. BRivals ignore price increases but match price cutsCorrect
  3. CRivals match price increases but ignore price cuts
  4. DRivals ignore both price increases and price cuts

Explanation

If a firm raises its price, rivals keep their prices unchanged, so the firm loses many customers and demand above the kink is elastic. If it cuts price, rivals follow, so it gains little extra sales and demand below the kink is inelastic. Option 3 reverses this and would give the opposite shape.

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