The kinked demand curve model of oligopoly assumes that

Question

Accepted Answer

The correct option is 1:

The kinked demand curve model, developed by Paul Sweezy, is used to explain price rigidity in an oligopoly market structure, where a few dominant firms exist. The core assumption of this model relates to the perceived reaction of rival firms to a change in price. Specifically, it assumes that rivals will *not* follow a price increase but *will* follow a price decrease. This difference in expected rival response creates the 'kink' in the demand curve. If a firm increases its price, rivals hold their prices constant (making demand relatively elastic, meaning the firm loses many customers). If a firm decreases its price, rivals match the price cut (making demand relatively inelastic, meaning the firm gains few extra customers). Therefore, the quantity response (demand/sales) to a price increase is larger (more elastic) than the quantity response to a price decrease (less elastic). This means the response (change in quantity demanded) is less when the price increases (as rivals don't follow) than the response when the price decreases (as rivals do follow, limiting the sales gain).

The incorrect option is 2: This is the opposite of the core assumption of the kinked demand curve model. The model suggests rivals will ignore price increases but match price decreases, leading to a weaker response (fewer lost sales) for a price increase than a price decrease.

The incorrect option is 3: The whole premise of the kinked demand curve is that the elasticity of demand is *not* constant; it is highly elastic above the current price (for price increases) and highly inelastic below the current price (for price decreases).

The incorrect option is 4: While the demand is elastic for price increases and inelastic for price decreases, the model does not assume *perfect* elasticity or *perfect* inelasticity; it assumes a change in elasticity at the kink point, not these extreme states. Perfect elasticity (horizontal demand curve) implies the firm loses all sales, and perfect inelasticity (vertical demand curve) implies quantity demanded does not change at all, neither of which accurately describes the kinked demand curve segments.