Reference no: EM133250446

1. In the model of Bertrand Competition we covered in class, we found that firms would compete, driving price down to marginal cost so that firms make zero economic profits. This means we have firms essentially behaving as if they are perfectly competitive, even with just two firms. Despite this very clear prediction, we do not often see evidence of this outcome, even in markets where we believe firms are indeed competing via price. Why might this be? For instance, what assumptions do we make about the costs of the firms and how might things play out if those assumptions fail? What are some things firms could do in this situation to prevent prices from dropping as low as marginal cost, even if our assumptions on costs are true?

2. Price competition between firms, from the firms' perspective, can be similar to the prisoners' dilemma. The best outcome for all firms would be for all to charge a high price. However, if the other firms charge a high price, any individual firm has incentives to charge a low price and steal the market. Additionally, if any other firm chooses a low price, each firm should charge a low price too so that it doesn't get priced out of the market.

A) Explain how price-matching (firms announcing a policy where they match the lowest price a customer can find or will honor a competitor's coupon) can help firms avoid the Nash equilibrium in which they all charge a low price. (Hint: What outcomes of the game are ruled out by the price-matching policy? How does ruling out these outcomes change the game and the decision the firms face?)

B) Is it misleading for a firm to advertise price-matching as being beneficial to consumers?