Bertrand Equilibrium

Continuing with other different models for firm interaction, our professor introduced the idea of choosing price versus choosing quantity as in the Cournot model, known as the Bertrand model. This focuses more on price competition. A key consideration is that in price competition (for homogeneous products) if firm 1 dropped it's price, it could capture the whole market. However, firm 2 is then incented to undercut the new price to recapture the market and the price cutting continues.

Where does it stop? It starts to move towards perfect competition immediately which is the crux of the model. Bertrand proposed that you could have a model which describes perfect competition with only two firms whereas Cournot required that perfect competition would occur where there were more firms in the market.

This highlights the importance of basing decisions on quatity versus price.