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    Question

    A firm observes that when it raises prices, competitors

    do not follow, leading to a significant loss of customers, whereas when it reduces prices, competitors quickly match the price cut, resulting in little gain in market share. This pricing behavior gives rise to a discontinuous marginal revenue curve. In which type of market structure is this situation most likely to occur?
    A Perfect competition Correct Answer Incorrect Answer
    B Oligopoly Correct Answer Incorrect Answer
    C Monopolistic competition Correct Answer Incorrect Answer
    D Monopoly Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    The scenario describes the kinked demand curve model, which arises in oligopolistic markets where firms are interdependent. A price increase is not followed by rivals, making demand highly elastic, while a price decrease is quickly matched, making demand inelastic. This creates a kink in the demand curve and a discontinuous marginal revenue curve, leading to price rigidity. The kinked demand curve is as below: The logic of the kinked demand curve is based on

    • A few firms dominate the industry
    • Firms wish to maximise profits
    Other market structures:
    • Perfect competition firms are price takers and do not face kinked demand.
    • Monopolistic competition features differentiated products but lacks strong strategic price reactions.
    • Monopoly faces a single downward-sloping demand curve without competitor reaction.
     

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