So, welcome everyone to this video

lecture.
And we're going to be talking about a
phenomenon that we call the Bertrand
Paradox.
And we'll split that in two.
First, we'll look at the theoretical
model in this video.
And then we'll look at relaxing some of
the assumptions and trying to find ways
of getting out of the Bertrand trap, or
Bertrand Paradox in the next video.
But, so what is the Bertrand model in the
first place.
We typically assume that there are two
companies and for a particular example
let's just take the example of two ice
cream sellers on a beach.
There is price competition and it's easy
in that case to think about two sellers
of ice cream just setting the prices for
this ice cream.
They both sell identical products, so
it's the same type of ice cream that both
of these sellers are stocking.
The game is played a single time, so
there's one day on which both players,
both ice cream manufacturers or sellers are
on the beach.
And they try to sell their ice cream so
it's price setting but it's just once.
You'll have market transparency, so
consumers know both prices, so everyone
knows the prices that
both firms will set.
And there's infinite price elasticity,
which means that no matter what the
price difference is, the seller with the
lower price will get all the consumers,
okay?
There also, finally, there are no capacity
constraints.
Which means that each of the sellers can
produce or can stock or can replenish
endless amounts of ice cream.
So, if we just take these assumptions.
Two companies, price competition,
identical products played once with full
market transparency, with infinite price
elasticity, and there are no capacity
constraints, then we can think of
analyzing this game pretty much as a
game
as we did in the five lectures
previously.
So, each seller can set a low price or a
high price.
So, that's if we have
competition between these two players
that just have two possible options.
And, if we just take the simplest
assumption here, we've got seller A and
seller B, and they can set either high
prices or low prices.
What we find is that if both
firms charge the same prices, then they
both share the market equally.
And if one of them charges the low price
they get market share of 100.
Okay?
So, in that very simple game we basically
get a Nash equilibrium where both firms
both sellers set low prices.
Now, prices though, are not typically a
discreet thing.
They're not a binary thing.
You can either charge high prices or low
prices.
You often have continuous prices, meaning
that you can charge the price of $1 or
$1.01 and $.02 and so on.
So, it's almost a continuous price that
we can set, so each seller sets any
price.
Now, what's interesting here is that we
find a unique Nash equilibrium where
both players charge prices equal to cost
if there are no fixed costs.
So, they charge prices equal to cost.
And profits are zero.
And that's very weird, isn't it?
Because in reality we see firms making
profits.
In this model, we see firms making zero
profit and charging very aggressive
prices,
charging prices equal to their marginal
cost.
And so this phenomenon, this paradox that
in real life we seem to see
positive profits and in this model we
don't,
is what we call the Bertrand paradox.
And we'll look at this Bertrand paradox
in more detail in the next video.
So, thanks very much and stay tuned.