Bertrand–Edgeworth Model

Published Mar 22, 2024

Definition of the Bertrand-Edgeworth Model

The Bertrand-Edgeworth model is a theoretical framework within economics that extends beyond the classic Bertrand competition by incorporating capacity constraints. This model is named after two economists, Joseph Bertrand and Francis Ysidro Edgeworth, who developed concepts of how firms compete on price within a market. Unlike the pure Bertrand model, which assumes infinite supply, the Bertrand-Edgeworth model acknowledges that firms have limited resources, which can lead to different market outcomes.

Example

Consider a scenario involving two gasoline stations located on opposite sides of a small town. These stations are in direct competition, setting their prices to capture or maintain their share of the market. According to the classical Bertrand model, if both stations had infinite supplies, they would continue lowering their prices until they reached the cost level, thus eliminating any possibility of making a profit.

However, in the Bertrand-Edgeworth model, if one station has a limited amount of gasoline due to, say, a supply disruption, this constraint on capacity changes the strategic dynamics. The station with the limited supply cannot serve all potential customers if it matches a price drop by the competitor. Therefore, it might choose to keep its prices slightly higher, knowing it cannot meet high demand regardless. This scenario leads to a situation where prices can be above marginal cost, allowing both stations to make a profit, even in a highly competitive environment.

Why the Bertrand-Edgeworth Model Matters

The Bertrand-Edgeworth model provides a more realistic view of market competition than models assuming infinite supply. This significance is twofold. First, it brings to light the strategic implications of capacity constraints on pricing strategies. Firms may not always engage in price wars to capture the market; instead, they might find stable, profitable pricing strategies even in competitive markets. Second, the model underscores the importance of supply chain management and capacity planning in maintaining competitive advantage and profitability.

Real-world market outcomes can be significantly influenced by the supply capacity of firms, and understanding these dynamics is crucial for both economists attempting to predict market behaviors and for managers tasked with strategic planning.

Frequently Asked Questions (FAQ)

How does the Bertrand-Edgeworth model differ from the Cournot model?

While both models seek to explain competitive strategies in oligopolistic markets, they differ in their core assumptions about how competition is conducted. The Bertrand model, including its extension through Bertrand-Edgeworth, focuses on price competition. Firms compete by setting prices, assuming their products are identical and that consumers will always buy from the cheaper supplier. The Cournot model, on the other hand, is based on quantity competition. Firms decide how much to produce, and the market price adjusts according to the total supply. The Bertrand-Edgeworth model, by introducing capacity constraints, provides a bridge by showing that quantity constraints can affect price competition outcomes.

Can the Bertrand-Edgeworth model apply to markets with more than two firms?

Yes, the principles of the Bertrand-Edgeworth model can extend to markets with more than two firms. As the number of firms increases, the model’s predictions become more complex due to the increased strategic interactions. However, the fundamental premise that capacity constraints affect pricing strategies remains applicable. With more firms, the market might segment into different pricing tiers, with some firms choosing not to compete aggressively on price due to their capacity limitations or strategic positioning.

Are there real-world examples where the Bertrand-Edgeworth model is observable?

Yes, there are numerous instances where the dynamics of the Bertrand-Edgeworth model can be observed in real-world markets, especially in sectors with significant capacity restrictions. Examples include airlines during peak travel seasons, limited-time offers on popular consumer goods, and the petroleum industry, where refining or distribution capacity limits can influence pricing strategies. These situations often demonstrate how firms strategically navigate capacity constraints to optimize profitability rather than engaging in detrimental price wars.