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Under the kinked demand curve model, the segment of the demand curve above the prevailing price is elastic because rivals are assumed to:
ANot follow a price rise, so the firm loses many customers
BMatch a price rise exactly, so the firm keeps its customers
CFollow a price cut, leaving market shares unchanged
DExit the industry whenever the firm raises its price
Answer & Solution
Correct answer: A. Not follow a price rise, so the firm loses many customers
1. If the firm raises its price, rivals are assumed to keep their prices unchanged.
2. Customers then switch from the dearer firm to its cheaper rivals.
3. A large fall in the firm's sales for a small price rise means demand is highly elastic.
4. So the segment above the prevailing price is elastic.
_Source: ICAI BoS CA Foundation Paper 4 Business Economics, Ch 4 Unit III "Price-Output Determination under Different Market Forms", p.28_
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