Multiple choice

The kinked demand curve model of oligopoly assumes that

  1. response to a price increase is less than the response to a price decrease

  2. response to a price increase is more than the response to a price decrease

  3. elasticity of demand is constant regardless of whether price increases or decreases

  4. elasticity of demand is perfectly elastic if price increases, and perfectly inelastic if price decreases
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A Correct answer
Explanation

The kinked demand curve model assumes that if an oligopolist raises prices, competitors will NOT follow (to gain market share), making demand above the kink highly elastic. However, if the oligopolist lowers prices, competitors WILL match the price cut to avoid losing customers, making demand below the kink relatively inelastic. This creates a kink at the current price and explains why prices tend to be rigid in oligopolistic markets.

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