Define the Bertrand model and its assumptions. Explain why the model predicts the perfectly competitive outcome despite the number of sellers. Discuss the limitations of the model.
What will be an ideal response?
The Bertrand model of oligopoly involves price competition with homogenous goods. Firms produce homogenous goods and set their prices simultaneously. At the equilibrium point in a Bertrand oligopoly, all sales occur at a price equal to marginal cost, the competitive outcome. If one firm charges more than marginal cost, there is an incentive for the other firm to undercut them and steal their customers. Because of this incentive, each firm charges the marginal cost so as not to be undercut and lose profits. The Bertrand model's assumptions are frequently unrealistic. For instance, one firm may not be able to steal all of another firm's profits, making that threat not credible. This may be due to a limited inventory or constraints on its capacity.
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Answer the following statement true (T) or false (F)