Page 568 - Microeconomics, Fourth Edition

c13marketstructureandcompetition.qxd 7/30/10 10:44 AM Page 542

542 CHAPTER 13 MARKET STRUCTURE AND COMPETITION
Cournot’s assumption of quantity-taking behavior and argued that a more plausible
model of oligopoly was one in which each firm chose a price, taking as given the prices
of other firms. Once firms choose their prices, they will then adjust their production
to satisfy all of the demand that comes their way. 14 If firms produce identical prod-
ucts, the firm that sets the lowest price captures the entire market demand, and the
other firms sell nothing.
To illustrate Bertrand price competition, let’s return to our Samsung–LG exam-
Bertrand equilibrium ple. A Bertrand equilibrium occurs when each firm chooses a profit-maximizing
An equilibrium in which price, given the price set by the other firm. Recall from Figure 13.2 that at the
each firm chooses a profit- Cournot equilibrium each firm produced 30 units and sold them at a price of $40
maximizing price given the (point E in Figure 13.5). Is this also the Bertrand equilibrium? The answer is no. To
price set by other firms.
see why, consider Samsung’s pricing problem in Figure 13.5. If Samsung takes LG’s
price as fixed at $40, Samsung’s demand curve D is a broken line that coincides with
S
the market demand curve D M at prices below $40 and with the vertical axis at prices
above $40. If Samsung slightly undercut LG’s price by charging $39, it would steal all
of LG’s business and would also stimulate one unit of additional demand. Thus,
Samsung more than compensates for its lower price by more than doubling its vol-
ume. As a result, Samsung’s profit increases by area B (the gain from the additional
volume of output it sells) minus area A (the reduction in profit due to the fact that it
could have sold 30 units at the higher price of $40).
But note that prices of $39 for Samsung and $40 for LG cannot be an equilibrium
either because LG would gain by undercutting Samsung’s price. Indeed, as long as both
firms set prices that exceed their common marginal cost of $10, one firm can always
increase its profits by slightly undercutting its competitor. This implies that the only
possible equilibrium in the Bertrand model is achieved when each firm sets a price
equal to its marginal cost of $10. At this point, neither firm can do better by changing its

$100 D M Samsung's demand curve
Samsung's price (dollars per unit) $40 D S A E

FIGURE 13.5 Bertrand Price Competition $39 B D S
If LG’s price is $40, Samsung’s demand curve
is the broken line D S . By setting a price of $10 MC
$39, Samsung can increase its profit by area
B minus area A. This tells us that each firm 0 30 60 61 90 100
charging a price of $40, with each producing Quantity (units per year)
30 units, is not the Bertrand equilibrium.

14 Bertrand writes: “By treating (the quantities) as independent variables, (Cournot) assumes that the one
quantity happening to change by the will of the owner, the other would remain constant. The contrary is
obviously true.” Ibid., p. 77.