Explain why the “kinked demand curve” model of oligopoly represents a

Explain why the “kinked demand curve” model of oligopoly represents a game theory approach to oligopolistic behavior.

What will be an ideal response?

ANSWER

Game theory usually is defined as studying how individuals form strategies when they are aware that their decisions affect the decisions of other which, in turn, will affect the outcome of their decisions. The “kinked demand curve” model is based on how firms perceive their competitors will react to any changes they make in their product prices, and how the expected reactions by competitive firms will affect firm profitability.

The typical assumption is that if the firm raises its product price, competitors will not raise their prices so that the firm will experience such a decrease in quantity sold that their total revenue and profit will decline. However, if the firm lowers its product price, competitors will match the price decrease so that the firm gains little or no increase in quantity sold, resulting in a decline in total revenue and profit. Under this expected behavior by competitors, firms should not alter their product prices in response to small changes in product costs.