According to the kinked demand curve model, if there is a modest incre

According to the kinked demand curve model, if there is a modest increase in a firm’s variable production costs, what is likely to happen to the firm’s profit-maximizing level of output and the amount of profit earned by the firm? Why?

What will be an ideal response?

ANSWER

Given the way the kinked demand curve model is constructed, there is a discontinuity in the firm’s marginal revenue function at the equilibrium price and output level. As a result, marginal cost can vary by some amount and leave the profit-maximizing level of output unaffected. If this is the case and variable costs increase, the firm’s total revenues will be unaffected but its total costs of production will be higher. Thus, the firm’s price and output levels remain the same, but total profit decreases.