Question

Market Structure Project 2020 - Compatibility Mode - Word Costs & Revenue Demand relatively ELASTIC MC P1 ATC Demand is relatively INELASTIC P2 ARD 01 O Q2 MR Output Copyright www.economics.co.uk Costs & Revenue MCI MC P1 P3 P A large increase in costs causes only a small increase in price ATO P2 AR=D Q1Q3 02 MR Output I a. What type of market structure is shown in the graph above and how did you determine this? b. What would make this type of market structure develop? c. What will the equilibrium price and quantity be under the conditions in the top diagram? d. Why would even a large increase in production costs result in only a relatively small price increase, if any, by the firm? e. Name an example of a firm that operates in a market of this type and explain how it qualifies as the market structure you identified f. What types of issues does this market structure create for customers? For regulators? Focus a w (2

Answer 1

a. The Kinked Demand Model of Oligopoly is shown in the above graphs and this is determined by the kinked demand and marginal revenue curve of the firm which is the case in Price Rigidity Model of Oligopoly.

b. The difference in the elasticities of demand of the product above a certain price range and difference in their elasticities below a certain price range, led to this type of the market structure and the firms not changes their prices even when demand of the product changes because of fear of losing their market share is an example of Price Rigidity Model.

c. The equilibrium in the above market occurs at the point where Marginal Revenue of the firm is equal to marginal cost of the firm. Thus, equilibrium quantity is equal to Q and equilibrium price is given by P.

d. In this cases, prices remain rigid and firms do not change their prices even when their cost changes because of the fear of losing their market share and rival firm not changeging their prices wwhich might lead to fall in the market share of the firm. Thus, in order to maximize their profit and unpredictability about the action of the rival firms, the firm prefer not change the prices of their good in this model even when their production cost changes.