Question

What's so paradoxical about the equilibrium outcome of the Bertrand competition? Explain.

Answer 1

In case of Bertrand competition, we have only few firms competing. Firms choose a price that maximizes their own profits given the price of other firms.

Firms will chose their prices simultaneously and there is no collusive behaviour.

Consumers are perfectly rational and they will choose a product that is priced lower. Hence, if a firm charges a higher price than its rival firms , the rival firm capture the entire market. If they charge same price, they will serve the market equally.

If suppose firm 1 charges a price higher than marginal cost, then its iival firm has incentive to undercut firm 1 by charging a price lower than firm 1 and just higher than MC. This will give the entire market to firm 2 . This process will keep on repeating and firms will keep on continue to undercut each other until it is no longer possible for them to undercut each other. This will happen when P1 = P2 = MC. At this price none of the firm can charge a lower price. Hence , equilibrium will be obtained at price equal to marginal cost.

This is a paradoxical solution because inspite of being just few firms in the market , firms operate at a perfectly competitive equilibrium i.e. P=MC , which is obtained when there are large number of firms present in the market. And obtain no profits.

Hence paradoxical.