Question

(a) What is the Bertrand trap faced by firms competing on setting prices? Explain in a few sentences.

Now let us consider the current trend of online sales. E-commerce (selling products in an online marketplace) represents an increasing fraction of economic transactions in many different industries compared to physical brick-and-mortar stores that sold products in the past.

(b) Does e-commerce create a Bertrand trap? (Hint: Discuss in terms of how online shopping affects (i) product differentiation and (ii) capacity constraints of sellers.)

(c) How can e-commerce firms possibly avoid the trap? (Hint: what strategies can help an online firm to distinguish itself from its competitor? You can use examples from the real world to support your answer.)

Answer 1

(a) Betrand competition is where there is interaction among firms which arr sellers that set prices and thrth customers that choose quantities at the prices set. Main assumption is that atleast two firms produce homogeneous product and cannot cooperate in any way. Firms simultaneously set prices to compete and consumers want to buy from that firm which set lower price because there is no consumer search costs. Both firms set the competitive price with price equal to marginal cost. No firms will earn any profits. If one firm sets price equal ti marginal cost and other firms set price higher than marginal cost, then it will earn nothing. So betrand trap is that where two firms reach nash equilibrium where both firms charge price equal to marginal cost. It is trap because if number of firms goes from one to two, the price decreases from the Monopoly price to competitive price and stays at the same level as the no. of firms increases beyond. It is not very realistic because real products are almost differentiated like brand name etc. Also two firms rarely have identical costs and firms also have limitations on their capacity to produce and sell.

(b) Similarly as betrand competition, e- commerce makes sellers look more alike, that means it reduces the degree of product differentiation. This implies it makes firms more inclined to fall in the Betrand trap. Brick and mortars have capacity constraints unlike online stores. They dont have any capacity constraints.They can pool the inventories at various physical locations which shows more chances of falling into a Betrand trap.

(c) But, e- commerce firms possibly avoid the trap. There can be ways in which an online company can differentiate itself, by make it more productive and efficient, and implementing appropriate strategies to increase customer satisfaction. For example, Amazon.com have successful branding strategy and a very good search engine with other services like Amazon Prime. And so have remarkable market share of loyal customers. Another example can be Zomato which jas maintained considerable market share through their innovate services for consumer satisfaction like Zomato gold membership ship etc.