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Difficulty: HardOligopoly: Characteristics, Types, and Price Interdependence

In an oligopolistic market for cement in Nigeria, a leading firm observes that if it raises its price above the prevailing market price of ₦4,000₦4,000 per bag, rival firms do not follow the price increase. Conversely, if it lowers its price below ₦4,000₦4,000, rival firms match the price reduction immediately. Which of the following best describes the price elasticity of demand facing this firm in these two price regions?

  1. Demand is relatively elastic above the prevailing price and relatively inelastic below it.Answer
  2. B
    Demand is relatively inelastic above the prevailing price and relatively elastic below it.
  3. C
    Demand is perfectly elastic above the prevailing price and unit elastic below it.
  4. D
    Demand is unit elastic above the prevailing price and relatively inelastic below it.

Answer

Demand is relatively elastic above the prevailing price and relatively inelastic below it.
The correct answer correctly identifies the dual elasticity nature of the kinked demand curve. Above the prevailing price, competitors do not raise their prices, so buyers switch to rival firms, making demand relatively elastic (Ed>1E_d > 1). Below the prevailing price, competitors match price reductions to maintain their market shares, preventing any firm from expanding sales significantly, making demand relatively inelastic (Ed<1E_d < 1). This asymmetry explains price rigidity in oligopolistic markets.

Step-by-Step Solution

1
Analyze competitor reaction to a price increase above the prevailing price of ₦4,000₦4,000.
Because rival firms do not match price increases, buyers switch to rivals, causing a disproportionately large drop in quantity demanded (demand is elastic, Ed>1E_d > 1).
Asymmetry in competitor behavior makes the upper section of the demand curve highly price-sensitive.
2
Analyze competitor reaction to a price reduction below the prevailing price of ₦4,000₦4,000.
Because rival firms immediately match price cuts to protect their market shares, the firm gains very few extra sales (demand is inelastic, Ed<1E_d < 1).
Matching price cuts prevents any single firm from gaining a competitive sales advantage.
3
Synthesize the elasticities to describe the overall shape of the oligopolist's demand curve.
The demand curve features a kink at the prevailing price, being relatively elastic above ₦4,000₦4,000 and relatively inelastic below ₦4,000₦4,000.
This structural difference in elasticity accounts for price rigidity in non-collusive oligopoly markets.

Key Concept

Kinked Demand Curve and Price Rigidity in Oligopoly
Estimated Time:1m 15s
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Topics

Oligopoly: Characteristics, Types, and Price Interdependence

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