Th3.4: Kinked Demand Theory

Question 1

Refer to PP

Look at Graph 36. What happens if a firm raises its prices?

Answer 1

other firms will not follow since they know their comparatively lower price means they are more competitive

Question 2

Refer to PP

Look at Graph 36. If a firm lowers its prices…

Answer 2

other firms will follow since they want to remain competitive

Question 3

Refer to PP

Look at Graph 36. Above P1 the curve is…

Answer 3

elastic - since competitors are offering lower prices

Question 4

Refer to PP

Look at Graph 36. Below P1 the curve is…

Answer 4

inelastic - since other firms lower their prices too so there is little difference in sales for the original firm

Question 5

Refer to PP

Look at Graph 36. What does this kink in demand mean?

Answer 5

there is a gap in the MR curve and so a rise or fall in costs or demand is likely to have no impact on price or output - prices tend to be oligopolistic because of this

Question 6

Refer to PP

Look at Graph 36. What is the problem with the kinked demand curve theory?

Answer 6

it assumes there is an initial price set within the market and does not explain why this price was set (however it does explain why prices tend to be stable)