A firm is convinced that if it lowers its price, no other firm in the industry will change price; however, it believes that if it raises its price, some other firms will match its increase, making its demand curve more inelastic. The current price is $8 and its marginal cost is constant at $4.
a. Sketch the general shape of the firm’s MR, MC, and demand curves and show why there are two possible equilibria.
b. If there are two equilibria, which of the two do you think the firms will arrive at? Why?
c. If the marginal cost falls to $3, what would you predict would happen to price?
d. If the marginal cost rises to $5, what would you predict would happen to price?
e. Do a survey of five or six firms in your area. Ask them how they believe other firms would respond to their increasing or decreasing price. Based on that survey, discuss the relevance of this kinked demand model compared to the one presented in the book.
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