Question

The Kinked demand curve model can explain 

(A) The level at which price will be set by firms to maximize profits. 
(B) The level of price at which the kink will occur as well as the height of the kink. 
(C) The price rigidity in the face of changing costs and of high rivalry. 
(D) The implications for the volume of output owing to changing market demand. 
Choose the correct answer from the options given below:
 

• A. (A) and (B) only
• B. (A), (B), and (C) only
• C. (A), (B), (C), and (D)
• D. (B) and (D) only

Hint:

In an oligopoly, firms tend to keep prices stable to avoid price wars. The kinked demand curve model explains why prices are sticky in such markets.

Answer 1

The Correct Option is B

Step 1: Understanding the Kinked Demand Curve Model. The kinked demand curve model elucidates price inflexibility in oligopolistic markets. Firms hesitate to alter prices for fear of customer attrition or initiating price wars. The model posits that firms will match price reductions but not increases, creating a kink in the demand curve at the prevailing market price.

Step 2: Analysis of Options.

• (A) Profit-maximizing price level for firms: Correct. The kinked demand curve model explains how firms determine a price point that maximizes profits due to the kink.
• (B) The price level and height of the kink: Correct. The kink signifies a stable price where firms are disinclined to raise it. The model also addresses the kink's height, reflecting market reactions to price shifts.
• (C) Price rigidity amidst cost fluctuations and high competition: Correct. The kinked demand curve model illustrates price rigidity, where competitive pressures deter firms from changing prices. The asymmetric market response to price increases versus decreases renders price adjustments risky.
• (D) Output volume implications from changing market demand: Incorrect. This model does not focus on output adjustments due to demand changes but rather on price rigidity stemming from oligopolistic competition.

Step 3: Conclusion. Options (A), (B), and (C) are correct as they accurately represent the core tenets of the kinked demand curve model.