Definition of Bertrand Competition
A market structure where it is assumed that there are two firms, who both assume the other firm will keep prices unchanged. Therefore, each firm has an incentive to cut prices, but this actually leads to a price war. If products are perfect substitutes this assumes the price will be driven down to marginal cost. This is allocatively efficient (P=MC) but firms may not cover their fixed costs.
Criticisms of Bertrand Competition
- It assumes firms do not learn from their mistakes. The initial assumption is that the other firm will keep prices constant, but when they see they also cut their price, they may change their behaviour.
- Firms in a duopoly should be able to make high profits. It depends on the degree of barriers to entry.
- With two firms, there is a possibility of tacit collusion – or at least a quiet industry which avoids a price war.
- It depends on the objectives of firms, for example, is it to profit maximise or increase market share. Bertrand Competition may be more likely if they are seeking to maximise sales.
- Consumers are not just motivated by buying the cheapest good. Their choices will reflect factors, such as brand loyalty, convenience, ease of purchase and quality of the good.