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      Question

      In the Sweezy Model of Oligopoly, the Kinked Demand

      Curve is used to explain why prices in oligopolistic markets remain relatively stable (Price Rigidity). What is the conceptual reason for the kink in the firm's demand curve?
      A Competitors will follow a firm’s price increase but ignore its price decrease. Correct Answer Incorrect Answer
      B Competitors will ignore a firm’s price increase but follow its price decrease. Correct Answer Incorrect Answer
      C The firm faces a perfectly inelastic demand curve for all price changes. Correct Answer Incorrect Answer
      D Marginal Revenue (MR) is equal to Average Revenue (AR) at the point of the kink. Correct Answer Incorrect Answer
      E The firm’s Marginal Cost curve is perfectly horizontal at the equilibrium point. Correct Answer Incorrect Answer

      Solution

      If a firm raises its price, competitors will not follow (to gain market share), making the firm's demand highly elastic (it loses many customers). If the firm lowers its price, competitors will follow (to prevent losing customers), making the demand inelastic (it gains very few new customers). This shift in elasticity at the current price level creates a "kink." Because of this kink, the Marginal Revenue (MR) curve has a vertical gap (discontinuity). As long as the Marginal Cost (MC) stays within this gap, the firm will not change its price, leading to price rigidity.

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