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Difficulty: MediumOligopoly: Characteristics, Types, and Price Interdependence

In Paul Sweezy's kinked demand curve model of a non-collusive oligopoly, what is the expected impact on a firm's total revenue if it unilaterally raises its product price above the prevailing market price?

  1. Total revenue falls substantially because demand is price elastic above the prevailing price, as rival firms do not follow the price increase.Answer
  2. B
    Total revenue increases significantly because demand is price inelastic above the prevailing price, as rival firms match the price increase.
  3. C
    Total revenue remains unchanged because the vertical gap in the marginal revenue curve keeps price and sales volume constant.
  4. D
    Total revenue increases because rival firms will immediately follow the price hike to maximize industry profits.

Answer

Total revenue falls substantially because demand is price elastic above the prevailing price, as rival firms do not follow the price increase.
In Paul Sweezy's non-collusive oligopoly model, rivals react asymmetrically to price changes. If a firm increases its price above the prevailing market level, rival firms will not follow, causing consumers to substitute away. As a result, demand above the prevailing price is relatively elastic (Ed>1E_d > 1). Raising prices along an elastic demand segment causes quantity demanded to drop by a larger percentage than the price increase, leading to a fall in total revenue.

Step-by-Step Solution

1
Identify rival firm response to a price increase in non-collusive oligopoly.
Rival firms maintain their current prices to attract customers away from the firm that raised its price.
Firms act competitively to gain market share when a competitor raises prices.
2
Determine the price elasticity of demand above the prevailing price (the kink).
Demand is price elastic (Ed>1E_d > 1) above the prevailing price.
Consumers easily switch to non-price-increasing competitors, causing a sharp drop in quantity demanded.
3
Analyze the impact of a price increase on total revenue along an elastic demand segment.
An increase in price leads to a proportionately larger reduction in quantity demanded, decreasing total revenue.
When Ed>1E_d > 1, price and total revenue move in opposite directions.

Key Concept

Asymmetric rival behavior and price elasticity in the kinked demand curve model
Estimated Time:1m 30s
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Topics

Oligopoly: Characteristics, Types, and Price Interdependence

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