Price Competition 373In their own inimitable way, Harding and Gillooly entangled themselves
in a classic prisoner’s dilemma: whether to hold out or implicate the other.
Once again, the cliche that fact imitates theory seems to have been vindi-
cated. Indeed, the case ended in dueling plea bargains. Gillooly pleaded
guilty to one charge of racketeering, subject to a maximum jail term of two
years, and was fined $100,000. Harding pleaded guilty to minor charges for
which she received probation, paid a $100,000 fine, and was forced to with-
draw from competitive skating. However, an earlier court injunction enabled
her to compete in the Winter Olympics, where she finished eighth. Nancy
Kerrigan, who was placed on the U.S. team, finished second and won the
Olympic silver medal.
Would the pair have escaped prosecution if they had refused to implicate
one another? To this question we probably will never know the answer.BERTRAND PRICE COMPETITION An extreme case of price competition orig-
inally was suggested by Joseph Bertrand, a nineteenth-century French econo-
mist. Suppose duopolists produce an undifferentiated good at an identical
(and constant) marginal cost, say $6 per unit. Each can charge whatever
price it wishes, but consumers are very astute and always purchase solely
from the firmgiving the lower price. In other words, the lower-price firm gains
the entire market, and the higher-price firm sells nothing.
To analyze this situation, suppose that each firm seeks to determine a price
that maximizes its own profit while anticipating the price set by its rival. In
other words, as in the previous example of quantity competition, we focus on
equilibrium strategies for the firms. (The difference is that here the firms com-
pete via prices, whereas previously they competed via quantities.) What are the
firms’ equilibrium prices? A little reflection shows that the unique equilibrium
is for each firm to set a price equal to marginal cost: P 1 P 2 $6. This may
appear to be a surprising outcome. In equilibrium, P AC MC so that both
firms earn zero economic profit. With the whole market on the line, as few as
two firms compete the price down to the perfectly competitive, zero-profit level.
Why isn’t there an equilibrium in which firms charge higher prices and
earn positive profits? If firms charged different prices, the higher-price firm
(currently with zero sales) could profit by slightly undercutting the other firm’s
price (thereby gaining the entire market). Thus, different prices cannot be in
equilibrium. What if the firms were currently charging the same price and split-
ting the market equally? Now either firm could increase its profit by barely
undercutting the price of the other—settling for a slightly smaller profit mar-
gin while doubling its market share. In summary, the possibilities for profitable
price cutting are exhausted only when the firms already are charging P AC
MC and earning zero profits.
The Bertrand model generates the extreme result that price competi-
tion, by as few as two firms, can yield a perfectly competitive outcome. Itc09Oligopoly.qxd 9/29/11 1:32 PM Page 373