4. What assumptions about a rival\'s response to price changes underlie the kink

Question

4. What assumptions about a rival's response to price changes underlie the kinked- demand curve for oligopolists? Why is there a gap in the oligopolist's marginal-revenue curve? How does the kinked-demand curve explain price rigidity in oligopoly? What are the shortcomings of the kinked-demand model? LO3 5. Why might price collusion occur in oligopolistic industries? Assess the economic desirability of collusive pricing. What are the main obstacles to collusion? Speculate as to why price leadership is legal in the United States, whereas price-fixing is not. LO3

Explanation / Answer

4. Assumptions: As in this model we assume that firms try to protect & maintain their market share by responding asymmetrically to a change in price of other firm.

1) If there is a fall in price of one firm’s product, rivals will follow same suite.

2) It is assumed that rival firms may neglect price increase.

3) If a firm increases price, rivals will pick up some of the firm’s customers. If the firm lowers price to lure customers from rivals, rivals will match the price decrease.

Gap:

There is a gap in Oligopolies MR curve because if a firm lowers price, a strong reaction comes from rivals in the form of industry wise price reduction. This leads MR to decrease significantly, causing a gap in the curve.

Shortcomings of Kinked demand Model:

1. First it fails to explain how to find the kinked point in demand curve.

2. There is only a limited real world evidence of this model.

3. Kinked demand model fails to explain Rivals behavior in case of price increase.

4. This model fails to explain why firms start at equilibrium price & quantity.

Related Questions

Navigate

• Browse (All)
• Browse 4
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.