Week 6 Bertrand Paradox I Theoretical Model Bertrand Model 2 companies 2 ice cream sellers on a beach Price competition Sellers set prices Identical products Same ice cream Game played once Price setting once Market transparency All consumers know both prices Infinite price elasticity Seller with lower price gets all customers No capacity constraints Each seller can produce endless amounts of ice cream Fixed Prices Seller A Each seller can set Low price High price Seller B High Low High 50% / 50% 0% / 100% Low 100% / 0% 50% / 50% Share of consumers Continuous Prices Each seller can set any price Unique Nash Equilibrium Prices equal costs (no fixed costs) Profits equal zero In reality firms do make profits. Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich © 2013 LMU Munich Week 6 Bertrand Paradox II Adjusting Model Assumptions Bertrand Model 2 companies Price competition Identical products Game played once Market transparency Infinite price elasticity No capacity constraints Model Assumptions (I/III) Identical products In reality, consumers have different taste and products are differentiated Monopolization not possible Each seller produces a different flavour of ice cream Game played once In reality, game has indefinite repetitions Collusion possible through threat of retaliation Every summer season, sellers set their prices Model Assumptions (II/III) Market transparency In reality, imperfect market transparency Undercutting prices has an effect on some consumers only Some consumers know price of one seller only Infinite price elasticity In reality, costs for consumers associated with switching seller Undercutting prices has limited effect Sellers introduce loyalty programme (e.g. 10th ice cream for free) Model Assumptions (II/III) No capacity constraints In reality, companies have limited capacity No incentive to induce a price war over the complete demand Each seller can produce limited amount of ice cream only What Firms Can Do Firms can actively influence these aspects to avoid the Bertrand trap Agree on prices, implicitly or explicitly Play the game repeatedly, make sure there is no endpoint Limit your capacity Increase switching costs Differentiate your product Competitive Strategy Tobias Kretschmer Professor of Management, LMU Munich © 2013 LMU Munich
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