Definition
In the Bertrand competition model, two firms simultaneously choose the price that presents the best response to the competitor’s price, competing for the buyer. The buyer purchases the goods from the firm who sets the lowest price, a key difference to Cournot Dupoly (in which the firms compete in quantity produced). The buyer purchases the good for the lowest price because the good is homogenous and price differentiation through competitive pricing strategies does not matter to the buyer. Thus, the firms are competing for the buyer (aka market share) purely through their pricing strategy, compared to the range of typical competitive pricing strategies.
Why It Matters
Bertrand competition shows us how businesses in an oligopoly behave when they are selling homogenous goods.
Example
For example, a firm could price above marginal cost, but there’s the possibility a competitor will undercut and steal the entire market.
Limitations
Per Tejvan Pettinger (2017), some limitations of Bertrand competition include:
1) in a duopoly, firms should be able to make high profits. “It depends on the degree of barriers of entry.”
2) The Bertrand game assumes companies are seeking to maximise sales, but some might be trying to maximise profits.
3) consumer choices are not always limited to just choices: factors include brand loyalty, convenience, ease of purchase and quality of the good
4) consumers don’t always have perfect information about the cheapest goods (although, this is changing in the information era)
5) there may be search and transaction costs of moving to a cheaper product
6) it is rare goods are homogenous
Further
Read more here.
References:
Tejvan Pettinger. “Bertrand Competition | Economics Help.” Economicshelp.org, 28 Nov. 2017, www.economicshelp.org/blog/glossary/bertrand-competition/.
Salish, Mirjam Sarah . “Bertrand Competition.” INOMICS, 5 Jan. 2021, inomics.com/terms/bertrand-competition-1504578.
