The paradox of the Bertrand Oligopoly with only 2-firms the equilibrium outcome is the same as a) monopolistic competition. b) monopoly c) tacit collusion d) perfect competition e) Cournot oligopoly
The correct answer and explanation is:
Correct Answer: d) perfect competition
Explanation (300 words):
The Bertrand paradox arises in the context of Bertrand oligopoly, where two or more firms compete by setting prices rather than quantities (as in Cournot competition). In the classic Bertrand model, the firms sell homogeneous products, have identical constant marginal costs, and simultaneously choose prices.
Here’s the surprising outcome: Even though there are only two firms, the Nash equilibrium of the game is that both firms set price equal to marginal cost—the same outcome as in perfect competition. This occurs because if one firm sets a higher price than the other, consumers will buy exclusively from the lower-priced firm. Hence, each firm has a strong incentive to undercut its rival by a small amount to capture the whole market. This price-cutting continues until price equals marginal cost, at which point no firm can profitably lower the price further.
This is counterintuitive because we usually associate a market with only two firms as being imperfectly competitive, possibly resembling a duopoly or a monopoly-like structure. However, the Bertrand model shows that price competition between just two firms can drive prices down to the perfectly competitive level if the assumptions hold.
Let’s consider the other options:
- a) Monopolistic competition: Involves product differentiation and firms have some price-setting power—prices are above marginal cost in equilibrium.
- b) Monopoly: A single firm sets price above marginal cost for profit maximization—not the case here.
- c) Tacit collusion: Involves firms cooperating implicitly to keep prices high, opposite of Bertrand behavior.
- e) Cournot oligopoly: Firms compete in quantities, and the equilibrium price is typically above marginal cost.
Therefore, the Bertrand paradox shows that even with just two firms, intense price competition can yield an equilibrium identical to perfect competition: price = marginal cost, zero economic profit.
Answer: d) perfect competition.