If price increases are ignored by other firms but price decreases lead to lowering of prices by competitors the firm will face a kinked demand curve as shown to the right, with the kink at the current market price of P*

   Keep in mind that the firm's belief that it faces a kinked demand curve comes from basic strategic considerations. It believes that competitors won't respond to price increases but that they will respond to price decreases. This in turn, means that the elasticity of the demand curve it faces depends on the direction of a price change. From here we use the simple logic of profit maximization to analyize behavior.

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