Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 622: Price competition and convex costs

Jörgen Weibull ()
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Jörgen Weibull: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: In the original model of pure price competition, due to Joseph Bertrand (1883), firms have linear cost functions. For any number of identical such price-setting firms, this results in the perfectly competitive outcome; the equilibrium price equal the firms’ (constant) marginal cost. This paper provides a generalization of Bertrand’s model from linear to convex cost functions. I analyze pure price competition both in a static setting - where the firms interact once and for all - and in dynamic setting - where they interact repeatedly over an indefinite future. Sufficient conditions are given for the existence of Nash equilibrium in the static setting and for subgame perfect equilibrium in the dynamic setting. These equilibrium sets are characterized, and it is shown that there typically exists a whole interval of Nash equilibrium prices in the static setting and subgame perfect equilibria in the dynamic setting. It is shown that firms may earn sizable profits and that their equilibrium profits may increase if their production costs go up.

Keywords: Bertrand competition

JEL-codes: D43

16 pages, First version: February 14, 2006. Revised: February 23, 2006.

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