Bertrand Competition

Definition

Bertrand competition refers to a model of price competition among firms where they simultaneously choose prices for their identical products, and the firm that sets the lowest price captures the entire market. This model illustrates how price setting can lead to Nash Equilibrium, where no firm has an incentive to change its price given the price set by its competitors, leading to a dominant strategy for firms to match lower prices to remain competitive.

5 Must Know Facts For Your Next Test

1. In Bertrand competition, firms with identical products will lower their prices until they reach marginal cost, resulting in zero economic profit.
2. The model assumes that consumers will always choose the lowest-priced product, leading to fierce price competition among firms.
3. Bertrand competition typically results in a more competitive outcome than Cournot competition due to the focus on price rather than quantity.
4. The presence of capacity constraints or differentiated products can alter the dynamics of Bertrand competition and lead to different equilibrium outcomes.
5. Nash Equilibrium in Bertrand competition indicates that when firms set the same price at marginal cost, no firm has an incentive to deviate from this strategy.

Review Questions

• How does Bertrand competition lead to a Nash Equilibrium in pricing strategies among firms?
  • In Bertrand competition, firms set prices simultaneously and strive to attract customers by offering lower prices. When firms reach a point where they set prices equal to marginal cost, they achieve a Nash Equilibrium because any attempt by one firm to raise its price would result in losing all customers to competitors. Thus, no firm has an incentive to change its price from this equilibrium, making it stable under these conditions.
• Discuss the implications of Bertrand competition for firms that engage in price-setting strategies compared to those that compete on quantity.
  • Firms engaged in Bertrand competition face intense pressure to continually lower prices, leading them to operate at marginal cost and earn zero economic profit. In contrast, firms that compete on quantity, as seen in Cournot models, may maintain positive profits by controlling output levels. This distinction emphasizes how strategic choices in competition—price versus quantity—can significantly impact firm profitability and market dynamics.
• Evaluate how the assumptions of Bertrand competition might change when introducing differentiated products and how this impacts market outcomes.
  • When introducing differentiated products into Bertrand competition, the assumptions shift significantly. Firms may not engage in pure price competition if consumers value product differences, allowing for positive pricing above marginal costs. This differentiation can lead to higher profits for firms as they establish brand loyalty and reduce direct price comparisons. The introduction of product differentiation creates a more complex competitive landscape where firms can leverage unique features to justify higher prices, altering traditional outcomes associated with homogeneous goods.

Related terms

Nash Equilibrium: A situation in game theory where no player can benefit by changing their strategy while the other players keep theirs unchanged.

Price Discrimination: The strategy of selling the same product at different prices to different customers based on their willingness to pay.

Cournot Competition: A model of competition where firms choose quantities to produce rather than prices, and compete based on the quantity of output they supply to the market.