2. Price rigidity and the kinked demand curve.

A. An analysis of the kinked demand curve helps in understanding why price changes without collusion in an oligopoly tend to happen infrequently. Draw the demand, marginal revenue, and marginal cost curves for an oligopolist that produces a differentiated product and assumes its rivals will not match its price changes. Indicate the profit-maximizing price and quantity on your graph. (5 points)

B. The oligopolist is charging the profit-maximizing price you found in part 2A. It, in effect, is operating as a monopoly and relying on price elasticity of demand to help it maximize its profits. Suppose it now assumes that its competitors will match its price changes. On the same graph, draw new, more inelastic demand and marginal revenue curves for this oligopolist. The old and new demand curves should intersect at the oligopolist's current price from part 2A. (5 points)

C. Compare the relative elasticity of the demand curves from parts A and B. Why is the elasticity different for the different demand curves? (4 points)

D. Now let's suppose that the oligopolist assumes that its competitors will not match its price increases, but will match its price decreases. On a new graph, draw the demand and marginal revenue curves. Draw a vertical line at the market price. To the left of the vertical line, show the demand and marginal revenue curves for the firm before the elasticity shifted. To the right, show the demand and marginal revenue curves for the more inelastic assumption. Where does the kink in the demand curve occur? What happens to the marginal revenue curve? (5 points)