Economics – Differing objectives and policies of firms | e-Consult

Explanation of Pricing Strategy: The kinked demand curve model predicts that the firm will maintain a constant price at the point where the demand curve is relatively inelastic. In this case, the firm's marginal revenue curve is relatively flat around a price of £10, indicating that the demand curve is relatively inelastic at this price. Therefore, the firm will likely choose to sell its output at £10.

Reasoning:

• If the firm raises the price above £10: The quantity demanded will fall significantly, and the marginal revenue will fall more than proportionally. This will lead to a decrease in total revenue.
• If the firm lowers the price below £10: The quantity demanded will increase only slightly, and the marginal revenue will increase less than proportionally. This will lead to a smaller increase in total revenue.

Limitations:

• Assumes Rivals React Perfectly: The model assumes that rivals will perfectly match price changes, which is unlikely in reality. Rivals might choose not to match, or they might choose to respond in a different way (e.g., by advertising or changing product features).
• Doesn't Account for Cost Changes: The model doesn't explicitly account for changes in the firm's costs. If the firm's costs change, it may need to adjust its price, even if the kinked demand curve model suggests that it should not.
• Simplistic Representation of Market Dynamics: The kinked demand curve model is a simplification of complex market dynamics. It doesn't capture all the factors that influence a firm's pricing decisions.