Chapter 23: Problem 25

According to the theory of the kinked demand curve, if a firm were to raise its price, its competitors would (LO3) a) lower theirs b) raise theirs c) keep theirs the same

Short Answer

Expert verified

According to the theory of the kinked demand curve, if a firm were to raise its price, its competitors would (c) keep their prices the same. This is because the more elastic demand in this situation encourages the firm to maintain its price at the current level, as consumers would be more likely to switch to substitute products offered by competitors if their prices remain unchanged.

Step by step solution

Option A - Analysis

Based on the kinked demand curve theory, when a firm raises its price, it makes the consumers more likely to switch to a substitute product, i.e. the good produced by one of the competitors. If the competitors would lower their prices in response, the demand for the increasing-price firm would decrease even more, making it less likely for the firm to increase its price in the first place.

Option B - Analysis

If a firm raises its price, and competitors follow by raising their prices as well, it would reduce the incentive for consumers to switch to a substitute product. However, according to the kinked demand curve, if the competitors raise their prices, the price-increasing firm would also want to raise its price further, leading to a potential price war.

Option C - Analysis

If the competitors keep their prices the same when a firm raises its price, the consumers are more likely to switch to a substitute product due to the increased price difference compared to the raising-price firm's product. This would make it less likely for the firm to raise its price in the first place, as the more elastic demand encourages the firm to maintain its price at the current level.

Correct Answer

Based on the kinked demand curve model, the correct answer is (c) keep their prices the same. According to the theory, when a firm raises its price, competitors are more likely to maintain their current prices, making the demand for the raising-price firm more elastic and discouraging the firm from increasing its price.

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