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OrtmannJEE2003 - Bertrand Price Undercutting A Brief...

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Winter 2003 21 Bertrand Price Undercutting: A Brief Classroom Demonstration Andreas Ortmann Abstract: The author presents a brief classroom demonstration illustrating Bertrand price undercutting. The demonstration is appropriate for micro princi- ples and intermediate- and upper-level undergraduate classes, as well as gradu- ate classes in micro, industrial organization, and game theory. Key words: Bertrand competitors, classroom experiments, collusion, price undercutting JEL codes: A1, A2, C7, D4 Bertrand price undercutting is arguably the key concept in analyzing the strate- gic interaction of price-setting oligopolists as well as in models of screening (e.g., Jehle and Reny 2001). This classroom demonstration translates a lesson about price undercutting into a demonstration that takes as little as 10 minutes and is likely to be remembered by students because of the significant amounts of money each of them could have earned. So far, not one student has earned a significant amount. I first present design and implementation of the classroom demonstration (the experiment). Then I discuss the game theoretic solution of the experiment and my experiences with it. I conclude by discussing related literatures. THE CLASSROOM DEMONSTRATION Design and Implementation After a standard lecture on Cournot and Bertrand duopolists and oligopolists (e.g., drawing on Stiglitz 1997; Schotter 2000; or Binmore 1992), I introduce an experiment on Bertrand price undercutting with the following instructions that I read aloud and project on a screen 1 : Each of you is one of (the number of students in class) sellers in a market in which an unspecified homogenous good is traded. If you all charge a price of 100 Czech Koruns, buyers (the number of students in class) will distribute themselves evenly and each of you will earn 100 Czech Koruns. Of course, because each of you hap- pens to be a Bertrand competitor, you are allowed to offer a lower price (nonnega- tive integers only). Marginal costs are zero, and fixed costs are zero. Andreas Ortmann is an assistant professor at the Center for Economic Research and Graduate Edu- cation of Charles University in Prague, Czech Republic, and a researcher at the Economics Institute of the Academy of Sciences of the Czech Republic (e-mail: [email protected]). The author appreciates the constructive comments of Andrew Austin and three anonymous referees.
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22 JOURNAL OF ECONOMIC EDUCATION Buyers are assumed to be price conscious and will go for the slightest of differences. The Bertrand competitor with the lowest price will therefore capture all of the mar- ket and will get (the number of students in class) x (difference between her or his price and the marginal cost). Bertrand competitors with identical bids share the spoils (buyers).
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