Question

4. A kinked demand curve can explain rigidity of oligopolists' administered price. What does inflexible, administered pricing mean? a. b. Why would an oligopolist have little motivation to change its price frequently? In the diagram below, assume that the equilibrium price is at point G. Is this over costs? Is the oligopolist earning economic profit? Explain C. d. At G there is a kink in the effective demand and marginal revenue curves of the oligopolist. Why? i. If it cuts price below G, will rivals follow? i. If it raises price above G, will rivals follow? Will customers leave this oligopolist and purchase from a rival? i. How do your answers to (i) and (ii) above explain the relative elasticity of the demand curve segment DG from the relative elasticity of the demand segment dG? curve iv. If improved productivity in labor to shift downward, what does the kinked demand curve analysis say about the likelihood that the oligopolist will share the improved productivity with its customers by lowering its price? capital causes the marginal cost curve or KINKED OLIGOPOLY DEMAND P D MC d AC E D MR Q QUANTITY PRICE LG

Answer 1

Answer 4:

a. The kinked demand theory states that a business might reach a stable profit maximizing equilibrium price and equilibrium quantity and have little incentive to alter prices. The kinked demand curve theory predicts periods of relative price stability under an oligopoly.This is referred to as inflexible pricing in oligopoly in case of kinked demand curve.

b. An oligopolist has little motivation to change its price frequently because a price rise by an oligopolist is not followed by its rivals and a price decline by an oligopolist is followed by the rivals and thus it is better to keep the prices stable in this theory.

c. Yes, the equilibrium price at point G is over the cost. The price is more than the average cost of the firm and thus the firm is earning economic profits in this case.

d. There is a kink in the demand curve because an increase in the price of the product above point G is not followed by its rivals and thus demand curve becomes flatter. On the other hand, a fall in the price of the product below point G, will be followed by its rivals and this makes the demand curve flatter in the lower segment.

i. Yes, if the price is cut below G, then the rivals will follow.

ii. No, if the prices are raised above G, then the rivals will not follow. yes, if the oligopolist keeps the prices high, then customers will not purchase from the oligopolist and purchase from the rivals.

iii. Above point G, where the prices are more than prevailing price, the elasticity will be high because price rise will not be followed by rivals. On the other hand, below point G, the price decline will be followed by another firms in the industry leading to decline in the value of elasticity and thus elasticity declines.

iv. Even with a reduced marginal cost, the prices will remain same in this model because kinked demand theory is based on stability of prices and prices generally stable and do not change even with the change in the marginal cost of production.