7. Understanding the kinked demand curve model Happyland is one of five amusemen
ID: 1144616 • Letter: 7
Question
7. Understanding the kinked demand curve model Happyland is one of five amusement parks on Sunshine Island. The following graph shows Happyland's kinked demand curve (D1 D2) and the resulting marginal revenue curve (MR1-MR2). The graph also shows two possible marginal cost curves (MC1 and MC2) 48 01 40 MR1 32 24 MC2 16 MR2 D2 0 2468 012 QUANTITY (ll tickets per year) Assume Happyland's marginal cost is represented by MC2. Happyland will set a price of per ticket. its price, other firms will do likewise to retain their market According to the kinked demand curve model, if one firm share, but if one firm price you just found for Happyland, its competitors will its price, other firms will not follow suit. Therefore, if Happyland decreases its price to below the The basic principle behind the kinked demand curve model explains why the D2 portion of the kinked demand curve is relatively elastic than the D1 port on If Happyland's marginal cost increased from MC2 to MC1 on the graph, Happyland wouldExplanation / Answer
From the graph, we see that MC1 = 14 and MC2 = 20. When the marginal cost is MC2, it is equal to 20. Hence, the market will produce a quantity where MR = MC2. Here MR will be 20 and so the quantity is 4 units. Happyland will charge a price of $40 per ticket
The model says that if one firm reduces the price, other firms will do likewise and if one firm increases its price, others will not follow. If Happyland reduces the price below $40, its competitors will also reduce the price.
From the graph, we see that D1 is flatter and D2 is relatively steeper. When demand is flat, it is elastic. Hence, D1 is relatively elastic and so D2 portion is relatively less elastic than D1 portion.
Even when the marginal cost changes from MC2 to MC1, there will be no change in the price charged and quantity produced because it remains under the valid range.
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