Bertrand model

Definition

The Bertrand model is an economic model that describes the behavior of firms in an oligopolistic market. It assumes that firms compete on the basis of price rather than quantity, and that they make their pricing decisions simultaneously.

5 Must Know Facts For Your Next Test

1. In the Bertrand model, firms compete on price rather than quantity, and they make their pricing decisions simultaneously.
2. The Bertrand model assumes that firms produce homogeneous products, and that consumers will purchase from the firm with the lowest price.
3. The Bertrand model predicts that firms will price at marginal cost, resulting in a perfectly competitive outcome, even in an oligopolistic market.
4. The Bertrand paradox arises when the Bertrand model predicts that firms will price at marginal cost, even though they have market power.
5. The Bertrand model is often used to analyze competition in markets with high fixed costs and low marginal costs, such as the airline industry or the telecommunications industry.

Review Questions

• Explain the key assumptions of the Bertrand model and how they differ from the Cournot model.
  • The Bertrand model assumes that firms compete on price rather than quantity, and that they make their pricing decisions simultaneously. This is in contrast to the Cournot model, which assumes that firms compete on quantity and make their output decisions simultaneously. The Bertrand model also assumes that firms produce homogeneous products, while the Cournot model allows for differentiated products. These differences in assumptions lead to different predictions about the outcomes in an oligopolistic market.
• Describe the Bertrand paradox and explain why it arises in the Bertrand model.
  • The Bertrand paradox arises when the Bertrand model predicts that firms will price at marginal cost, even though they have market power. This is paradoxical because in a typical oligopolistic market, firms would be expected to price above marginal cost and earn positive profits. The Bertrand paradox arises because the model assumes that firms will undercut each other's prices until they reach the perfectly competitive outcome of pricing at marginal cost. This is a result of the model's assumption that firms compete on price rather than quantity, and that consumers will always purchase from the firm with the lowest price.
• Analyze the real-world applicability of the Bertrand model and discuss the factors that may limit its usefulness in describing oligopolistic markets.
  • While the Bertrand model provides a useful theoretical framework for understanding price competition in oligopolistic markets, its real-world applicability is limited by several factors. First, the assumption of homogeneous products may not hold in many industries, where firms often compete on product differentiation. Second, the assumption of simultaneous price-setting may not accurately reflect the dynamic nature of pricing decisions in many markets. Firms may engage in strategic pricing behavior, such as price leadership or price matching, which the Bertrand model does not capture. Additionally, the Bertrand model's prediction of pricing at marginal cost may not be observed in practice, as firms often have the ability to maintain prices above marginal cost due to factors such as brand loyalty, switching costs, or entry barriers. As a result, the Bertrand model is most useful as a theoretical benchmark, but its predictive power may be limited in real-world oligopolistic markets.

Related terms

Oligopoly: A market structure in which a small number of firms dominate the industry, and their decisions and actions significantly influence the market.

Nash Equilibrium: A situation in which each player's strategy is the best response to the other players' strategies, and no player has an incentive to deviate from their strategy.

Cournot Model: An economic model that describes the behavior of firms in an oligopolistic market, where firms compete by setting their output levels simultaneously.