A firm with a kinked demand curve experiences an increase fixed costs. Explain how the firm's price, output and profit change.
To understand how the price, output, and profit of a firm with a kinked demand curve change when fixed costs increase, let's first explain the concept of a kinked demand curve.
A kinked demand curve is a demand curve that shows a non-linear relationship between the firm's price and the quantity demanded by consumers. It consists of two distinct segments with different elasticities of demand: an elastic segment, where competitors' reactions are expected to be aggressive, and an inelastic segment, where competitors' reactions are expected to be less aggressive.
Now, considering the increase in fixed costs, which are costs that do not vary with the level of output, we need to analyze the effects on each of the variables:
1. Price: In most cases, an increase in fixed costs does not directly affect the firm's price. The price is typically determined by factors such as market demand, production costs, and competitors' actions. However, if the firm experiences a decrease in demand due to the increase in fixed costs, it may choose to lower its price to stimulate demand and maintain market share.
2. Output: The impact of increased fixed costs on output depends on various factors, including the elasticity of demand in each segment of the kinked demand curve. If the demand in the elastic segment is relatively price-sensitive, the firm may respond to increased costs by reducing its output to avoid a significant decrease in its price. Conversely, in the inelastic segment, where demand is less sensitive to price changes, the firm may be able to increase output without causing a substantial decrease in price.
3. Profit: When fixed costs increase, the effect on a firm's profit depends on how the changes in price and output affect its revenue and costs. If the decrease in output due to higher fixed costs leads to a decline in revenue that outweighs the cost savings from reduced output, profits may decrease. Conversely, if the firm manages to maintain its price and increase output in the inelastic segment, it may be able to generate additional revenue that surpasses the increased fixed costs, resulting in higher profits.
In summary, an increase in fixed costs for a firm with a kinked demand curve may lead to a potential decrease in output and profits. However, the specific impact on price, output, and profit will depend on the elasticity of demand in each segment of the kinked demand curve and the firm's ability to adjust its strategy accordingly.