Econ HW Ch. 11

Price cuts can be quickly and easily matched by a

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Unformatted text preview: ut Q0 will result from such a shift. Because of the sharp difference in elasticity of demand above and below the going price, there is a gap, or what we can simply treat as a vertical segment, in the marginal- revenue curve. The kinked- demand curve gives each oligopolist reason to believe that any change in price will be for the worse. If it raises its price, many of its customers will desert it. If it lowers its price, its sales at best will increase very modestly since rivals will match the lower price. Even if a price cut increases the oligopolist’s total revenue somewhat, its costs may increase by a greater amount, depending on demand elasticity. The kinked- demand analysis has two shortcomings. First, it does not explain how the going price gets to be at P0 in the first place. It only helps explain why oligopolists tend to stick with an existing price. The kinked- demand curve explains price inflexibility but not price itself. Second, when the macroeconomy is unstable, oligopoly prices are not as rigid as the kinked- demand theory implies. During inflationary periods, many oligopolists have raised their prices often and substantially. And during downturns (recessions), some oligopolists have cut prices. In some instances these price reductions have set off a price war: successive and continuous rounds of price cuts by rivals as they attempt to maintain their market shares. #10. Price collusion occurs in oligopolistic industries because it allows oligopolists to reduce uncertainty, increase profits, and perhaps even prohibit the entry of new rivals. It usually occurs whenever firms in an industry reach an agreement to fix prices, divide up the market, or otherwise restrict competition among themselves. The main obstacle is the danger of a price war breaking out. A new firm may also surmount entry barriers and initiate aggressive price- cutting to gain a foothold in the market. Price leadership is legal in the United States as opposed to price- fixing because it is not based on formal agreements and secret meetings – it is basically a less obvious mean of price control that developed from the antitrust law. #11. Monopolistic competitors and oligopolists prefer nonprice competition and hence has a...
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