The kinked demand curve theory of oligopoly suggests that :
Price cuts are matched by rivals, but price increases are not
Rivals match a price cut but ignore a price rise — option 2.
The model. Put forward by Paul Sweezy in 1939, and independently by Hall and Hitch, the kinked demand curve explains why prices in an oligopoly are so sticky even when costs change. Its whole content is an assumption about how rivals will behave :
| If a firm | Rivals | Consequence for the firm | Demand it faces |
|---|---|---|---|
| Raises its price | Do not follow — they are glad to keep their lower price | Loses a great many customers to them | Elastic — the flatter upper segment |
| Cuts its price | Match at once, to protect their share | Gains very little, since relative prices are unchanged | Inelastic — the steeper lower segment |
The demand curve therefore has a kink at the prevailing price: flat above it, steep below it.
Why that produces sticky prices. A kink in the demand curve puts a discontinuity — a vertical gap — in the marginal revenue curve directly beneath it. The firm maximises profit where marginal cost cuts marginal revenue, and as long as the marginal cost curve passes anywhere through that vertical gap, the profit-maximising price does not move. So marginal cost can rise or fall over a range without the firm changing its price at all, which is the observation the model was built to explain.
Why the other options fail. Option 3 reverses the assumption exactly; option 1 describes a monopoly with no rivals to worry about; option 4 describes perfect competition, where the individual firm is a price taker facing a horizontal demand curve, not a kinked one.
The standing criticism, made by George Stigler, is that the model explains why a price, once established, stays put — but says nothing about how that price was arrived at in the first place. It is a theory of price rigidity, not a theory of price determination.
Hence, the answer is price cuts are matched by rivals, but price increases are not.
Similar Questions
Given below are two statements : one is labelled as Assertion (A) and the other is labelled as Reason (R).
Assertion (A) : In monopolistic competition, firms face a downward-sloping demand curve that is more elastic than under monopoly.
Reason (R) : In monopolistic competition, close substitutes of the product are available in the market.
In the light of the above statements, choose the most appropriate answer from the options given below :
For perfect competition, indicate the correct code for essential conditions from the following :
(a) Large number of buyers and sellers
(b) Perfect knowledge of the market
(c) Homogeneous product for sale
(d) Absence of transportation cost
(e) Freedom of entry and exit of buyers and sellers from the market
(f) Rational Behaviour of buyers and sellers
Code :
The market share data for an industry, comprising five companies, is given below :
Company Market Share (%) A 35 B 25 C 18 D 12 E 10 This industry’s three-firms Herfindahl-Hirschman index shall be :
Match the items of List-I with the items of List-II and find the correct combination:
List - I
(Market Structure)List - II
(Nature of industry where prevalent)(a) Perfect competition (i) Aluminium and passenger cars (b) Oligopoly (ii) Public utilities like Telephones and Electricity (c) Monopoly (iii) Manufacturing : T.V. Sets, Refrigerators (d) Monopolistic competition (iv) Farm Products : Grains The Competition Commission of India has no role in regulating which of the following?
Consider the following statements:
(1) Exclusive dealing amounts to a restrictive agreement under the Competition Act, 2002.
(2) The rate of growth in the service sector in India is highest among all the other sectors of economy.
(3) Predatory pricing is not regulated under any law.
(4) A company using sales force promotion and trade promotion is using "Pull" strategy.
Indicate the correct answer out of the following:
Important Questions from Business Competition
Select the correct code of the following statements being correct or incorrect.
Statement (I) : The ‘law of one price’ states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
Statement (II) : An ‘Efficient market’ has no impediments to the free flow of goods and services, such as trade barriers.
Which one of the following is not true for introducing multiple brands in a category?
The shut down refers to complete cessation or closing down of the business. It involves which of the following?
i) No buying or selling
ii) No manufacturing
iii) Shifting of business from one place to another place
iv) Assets to be sold or disposed off
v) Returning capital to owners
Which of the following is a guideline to deal with colleagues?
Which of the following is a horizontal agreement?
