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    Industrial Organization Worked Example 4 Bertrand-Nash Equilibrium

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    Oliver Gannon
    This document provides a worked example of a Bertrand-Nash equilibrium between two firms. It shows that when firms produce goods that are not perfect substitutes, their equilibrium prices can differ and exceed marginal cost. The example calculates the reaction functions for two firms with different costs and demands. It finds that at the Bertrand-Nash equilibrium, firm 1 charges $5.30 and firm 2 charges $4.60, with both firms lying on their respective reaction functions.

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    Industrial Organization Worked Example 4 Bertrand-Nash Equilibrium

    Uploaded by

    Oliver Gannon
    30 views2 pages
    This document provides a worked example of a Bertrand-Nash equilibrium between two firms. It shows that when firms produce goods that are not perfect substitutes, their equilibrium prices can differ and exceed marginal cost. The example calculates the reaction functions for two firms with different costs and demands. It finds that at the Bertrand-Nash equilibrium, firm 1 charges $5.30 and firm 2 charges $4.60, with both firms lying on their respective reaction functions.

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    Bertrand Nash Equilibrium

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    This document provides a worked example of a Bertrand-Nash equilibrium between two firms. It shows that when firms produce goods that are not perfect substitutes, their equilibrium prices can differ and exceed marginal cost. The example calculates the reaction functions for two firms with different costs and demands. It finds that at the Bertrand-Nash equilibrium, firm 1 charges $5.30 and firm 2 charges $4.60, with both firms lying on their respective reaction functions.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    30 views2 pages

    Industrial Organization Worked Example 4 Bertrand-Nash Equilibrium

    Uploaded by

    Oliver Gannon
    This document provides a worked example of a Bertrand-Nash equilibrium between two firms. It shows that when firms produce goods that are not perfect substitutes, their equilibrium prices can differ and exceed marginal cost. The example calculates the reaction functions for two firms with different costs and demands. It finds that at the Bertrand-Nash equilibrium, firm 1 charges $5.30 and firm 2 charges $4.60, with both firms lying on their respective reaction functions.

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    Download as PDF, TXT or read online from Scribd
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    Worked Example: Industrial Organisation 4 Bertrand Nash Equilibrium

    Industrial Organization Worked Example 4 Bertrand-Nash Equilibrium


    In a Bertrand Nash equilibrium the strategic variable is price. In a Bertrand-Nash equilibrium each firm charges the price which maximises its profits, given the prices charged by the other firms. Suppose all firms in an industry have the same constant marginal cost c. Suppose also that their customers regard the outputs of the different firm as perfect substitutes, so they buy only from the firm with the lowest price. Then in the Bertrand Nash equilibrium all firms charge a price c. See Katz and Rosen pages 504-510. However if firms produce goods which are not perfect substitutes the Bertrand-Nash equilibrium prices can differ from each other, and exceed marginal cost. Suppose that there are two firms. Firm 1 produces at a constant marginal cost of 1 and faces demand q1 = 10 - 2p1 + 2p2 . Firm 2 produces at a constant marginal cost of 2 and faces demand q2 = 11 3p2 + 2p1. If firm 2 sets a price p2 firm 1s profits are 1 = (p1 1)q1 = (p1 1)( 10 - 2p1 + 2p2)

    For fixed p2 firm 1s profits 1 are maximised when 1 __ p1 = 10 - 2p1 + 2p2 2p1 + 2 = 12 4p1 +2p2 = 0.

    so p1 = 3 + p2 . This is the reaction function of firm 1.

    file:///J|/EC201/Designer2003/BertrandNashEquilibrium.htm (1 of 2)22/03/2006 15:55:46

    Worked Example: Industrial Organisation 4 Bertrand Nash Equilibrium

    If firm 1 sets a price p1 firm 2s profits are = (p2 - 2)q2 = (p2 2)(11 3p2 + 2p1).

    For fixed p1 firm 2s profits are maximised when

    2 __ p2

    = 11 3p2 + 2p1 3p2 + 6 = 17 6p2 + 2p1 = 0

    so p2 = 1/3 p1 + 17/6 . This is the reaction function of firm 2. In the Bertrand Nash Equilibrium both firms lie on their reactions functions, that is p1 = 3 + p2 and p2 = 1/3 p1 + 17/6 which implies that p1 = 5.3 and p2 = 4.6. Firm 1 sells q1 = 10 - 2p1 + 2p2 = 8.6 and makes profits q1(p1 1) = 36.98. Firm 2 sells q2 = 11 3p2 + 2p1 = 7.8 and makes profits q2(p2 2) = 28.08.

    file:///J|/EC201/Designer2003/BertrandNashEquilibrium.htm (2 of 2)22/03/2006 15:55:46

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