Bertrand and cournot competition comparison

Within the realm of industrial economics, a central focus is on equilibrium in oligopoly models, and the questions arise of how the firms would find the equilibrium and whether they will choose it. The efforts of this essay are devoted to a discussion of Court and Bertrand models of competition, two fundamental single-period models that form the basis for multi-period models (Friedman, 1977).

Firstly the essay will give an introduction to the properties of the Court and Bertrand models of intention and examine their implications to the relationship between structure and performance. Then it will theoretically address the question that when and how we can choose either of these two models to better describe a market, and empirically distinguish between two models by giving example industries that behave according to each. Finally the essay will draw a conclusion.

Oligopoly theory abstracts from the complexity of real-life corporate strategy, and concentrates on Just one or two strategic variables (Davies et al, 1991). Court (1838) takes the view tat the firm¤ass strategic variable is squatty or output. In contrast, Bertrand (1883) takes the view that the firm¤ass basic strategic variable is price. In order to capture the distinction between the Court and Bertrand framework, we will consider the simplest case of homogeneous products.

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First, given positive market share, firms in Court market have the market power to price higher than their marginal costs. Second, the market power of a firm is limited by the market elasticity of demand. The more elastic demand, the lower the price-cost margin. Furthermore, given that all the firms are price takers, firms with lower marginal cost will have greater markets shares. Then what is the implication for the relationship between structure and performance guarding the industry as a whole?

Turning to this aspect, summing the average price-cost margin follows summing individuals firms over all n firms weighting each firm¤ass margin by its share of the market, Where H denote Heralding index, which is one of the most widely accepted measures of concentration. If we use concentration as the measure of industry structure and price-cost margin as the measure of performance, we can see that in Court competition, the less elastic is demand, and the larger is the Heralding index, the greater aggregate margin in the Court Nash equilibrium.

Also, the market power (Unmans, 1962), this indicates the importance of barriers to entry. In 1883, Bertrand criticized Court¤ass work on several counts. One of these was that if the strategic variable is price rather than quantity, Court¤ass logic results in an entirely different outcome (Friedman, 1977). In the Bertrand framework each firm directly controls the price at which it sells it output, and the demand for its output will depend on the price set by each firm 3 and the amount that they wish to sell at that price.

This model is driven by the assumption that the firm that charges the lowest price can capture marginal cost in the market, it can charges a price, where is the marginal cost the entire market (Walden and Jensen, 2001). Given this assumption, if firm I has the lowest of the firm that has the second lowest marginal cost in the industry, and I poi pipe represents a number that is infinitesimally greater than O. Then firm I will capture the entire market.

In the case that each firm face an identical marginal cost, each firm will set its rice pi equal the marginal cost, and yields a competitive equilibrium. The discussion about Bertrand framework tells a very different story of the relationship between structure, conduct, and performance from the Court-Nash equilibrium. First, only the most efficient firm will survive the competition and become the monopolist, the other firms will exit the market. Second, if all firms face the identical marginal cost, with two or more firms the competitive outcome occurs, large numbers (which is the case in Court competition) are not necessary.

Clearly, there is a big difference whether the strategic variable is price or quantity. Therefore, what criteria do we have for choosing between Court or Bertrand model to describe a market? A common argument for the Court model is more appropriate is that it captures the intuition that competition decreases with fewer firms, while the prediction of the Bertrand model ¤00 a zero price-cost margin with two or more firms, or only one firm exists as the monopolist ¤00 is implausible.

In the world, examples like many consumer goods markets have shown that it is hard to find all consumers want to buy from the firm charging the lowest price, and small price hangs by a firm lead to small changes in its sales and in the sales of its rivals (Friedman, 1977). Also, it is often argued that the choice of Court and Bertrand lies in the relative flexibility of prices and output. In the Court framework, once chosen, outputs are fixed, while the price is flexible.

In the Bertrand framework, however, firms set prices while output is 4 quantities (Davies et al, 1991), and therefore the Court framework is preferred to the Bertrand framework. An influential work coloring this view is Krebs and Chainman (1983). In their two-stage model, firms choose capacities in the first tags, and compete with price as in the Bertrand model up to the capacity chosen in the first stage. The resultant equilibrium turns out to be equivalent to the standard Court model.

There do have some industries where firm¤ass behavior is consistent with the intuition of Bertrand model. In the American airline industry, many major carriers follow a policy of pricing near marginal cost on routes on which it faces competition (Walden and Jensen, 2001). They fear that if their fares are even slightly higher than the competitor, they will lose virtually the entire market share. However, Brander and Ghana (1990) also found evidence that the pricing behavior of American Airlines and United Airlines between 1984 and 1988 were close to the Court model¤ass prediction.

In addition, Await (1974) found that in the Japanese flat-glass industry the two duopolistic behave according the the Court competition. In conclusion, this essay has compared and contrasted the main properties of Court and Bertrand models of competition, clearly the two models tell completely different stories of oligopolies competition as well as the relationship between structure and performance. The essay has also discussed when and which of the two oodles are expected to be better describe a market, both theoretically and with empirical examples.

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