2. Facepalm, Instarant, and Snaphat are rival firms in an oligopoly industry. If kinked-demand theory applies to these three firms, Facepalm’s demand curve will be:
a. more elastic above the current price than below it.
b. less elastic above the current price than below it.
c. of equal elasticity both above and below the current price.
d. none of the above.

Question

2. Facepalm, Instarant, and Snaphat are rival firms in an oligopoly industry. If kinked-demand theory applies to these three firms, Facepalm’s demand curve will be: 
a.     more elastic above the current price than below it.
b.     less elastic above the current price than below it.
c.     of equal elasticity both above and below the current price.
d.     none of the above.

BlackTom AI · Accepted Answer

Kinked-demand theory assumes rivals match price decreases but not price increases, so the firm's demand curve is more elastic above the current price than below it (option a).

1. Relevant knowledge points and concepts
- Oligopoly: a few firms whose pricing decisions affect one another.
- Kinked-demand curve: a model where each firm believes rivals will not follow price increases but will follow price decreases.
- Price elasticity of demand: measures how quantity demanded responds to a price change. If small price increases cause large quantity losses, demand is elastic; if price decreases do not raise quantity much (because rivals match cuts), demand is inelastic.

2. Complete reasoning process step by step
- Step 1: Assume the firm is at the prevailing industry price P0 and quantity Q0.
- Step 2: If the firm tries to raise its price above P0, rivals are expected to keep prices at P0. Consumers then switch to rivals, so the firm loses many customers — demand above P0 is relatively elastic.
- Step 3: If the firm lowers its price below P0, rivals are expected to match the cut to protect market share. The firm therefore gains little additional quantity despite the lower price — demand below P0 is relatively inelastic.
- Step 4: Combining these behaviours produces a demand curve with a “kink” at (P0, Q0): a flatter (more elastic) segment above the kink and a steeper (less elastic) segment below it.

3. Intermediate steps / illustrative example
- Suppose P0 = $10, Q0 = 100. Raise to $11 and rivals stay at $10 → Q falls to 40 (large drop → elastic). Lower to $9 and rivals match → Q rises to 110 (small rise → inelastic). These hypothetical numbers illustrate elasticity differences on either side of P0.

4. Why the correct answer is correct
- The kinked-demand assumption about rival responses directly yields greater elasticity for price increases (above current price) and lower elasticity for price decreases (below current price). Hence “more elastic above the current price than below it” is the correct characterization.

5. Why other options are incorrect
- b (less elastic above than below) contradicts the rivals’ predicted behavior; if rivals don’t follow increases, demand above is not less elastic. c (equal elasticity) ignores the asymmetric rival reactions that create the kink. d is wrong because option a correctly describes the kinked-demand implication.

6. Conclusion
- Therefore the correct answer is a, which matches the provided answer.

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