A Level Economics AQA Practice Exam

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What does the kinked demand curve illustrate?

The price elasticity of a monopolistic market
How demand changes at varying price levels among consumers
The response of rivals to price changes in an oligopoly
The correlation between cost and supply

The correct answer is: The response of rivals to price changes in an oligopoly

The kinked demand curve is specifically designed to illustrate the behavior of firms within an oligopoly, particularly how they anticipate and react to price changes made by their competitors. In markets that are characterized by a few dominant firms, it is often the case that if one firm lowers its prices, others will follow suit to maintain their market share. This creates a kink in the demand curve, where the upper portion reflects inelastic demand (consumers are less responsive to price increases) because rivals will not follow a price increase, while the lower portion reflects elastic demand (consumers are more responsive to price reductions) since rivals will match price drops. This illustrates the interdependence of firms, a key feature of oligopolistic markets. Therefore, the kinked demand curve captures the idea that firms are reluctant to change prices because of the anticipated reactions of their competitors, leading to price rigidity in the market.