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Difficulty: HardOligopoly: Characteristics, Types, and Price Interdependence

In a non-collusive oligopolistic market for wireless telecommunication services, a major network provider operating at an equilibrium price of P0P_0 observes that raising its subscription rates leads to a sharp decline in total revenue, while lowering rates below P0P_0 yields negligible changes in sales volume. Based on the kinked demand curve model, which of the following explains this asymmetric revenue outcome?

  1. Rival firms ignore price increases, making demand relatively elastic above P0P_0, but match price cuts, making demand relatively inelastic below P0P_0.Answer
  2. B
    Rival firms match price increases to protect profit margins, making demand inelastic above P0P_0, but ignore price cuts, making demand elastic below P0P_0.
  3. C
    The firm operates on a perfectly elastic demand curve both above and below P0P_0 due to formal collusion among market leaders.
  4. D
    Rival firms ignore both price cuts and price increases, causing a horizontal shift in the firm's marginal revenue curve.

Answer

Rival firms ignore price increases, making demand relatively elastic above the prevailing price, but match price cuts, making demand relatively inelastic below the prevailing price.
Under non-collusive oligopoly, Paul Sweezy's kinked demand curve model assumes asymmetrical rival behavior: competitors ignore price increases (making the demand curve elastic above the prevailing price P0P_0) and match price cuts (making the demand curve inelastic below P0P_0). This causes total revenue to fall when prices are raised and fail to increase when prices are lowered, reinforcing price rigidity at P0P_0.

Step-by-Step Solution

1
Analyze the price increase scenario above the prevailing price P0P_0.
If the firm raises price above P0P_0, competitors do not follow because they can capture switching customers. Consequently, quantity demanded falls drastically, demonstrating that demand is relatively price elastic (Ed>1E_d > 1). Total revenue falls.
Competitors seek to gain market share at the expense of the price-raising firm.
2
Analyze the price cut scenario below the prevailing price P0P_0.
If the firm lowers price below P0P_0, competitors immediately match the price cut to prevent losing their customers. The initiating firm gains very little additional quantity, demonstrating that demand is relatively price inelastic (Ed<1E_d < 1). Total revenue does not rise significantly.
Competitors protect their existing customer base from price undercutting.
3
Combine the two behavioral responses to explain the asymmetric revenue outcome.
The asymmetry in rival behavior creates a 'kink' in the demand curve at price P0P_0, resulting in price rigidity, as any price movement away from P0P_0 decreases or fails to meaningfully improve total revenue.
Paul Sweezy's kinked demand model accounts for mutual interdependence under non-collusive oligopoly.

Key Concept

Price Interdependence and Sweezy's Kinked Demand Curve Model
Estimated Time:1m 30s
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Topics

Oligopoly: Characteristics, Types, and Price Interdependence

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