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Does Cost Uncertainty in the Bertrand Model Soften Competition?

Johan N. M. Lagerlöf

University of Copenhagen - Department of Economics; Centre for Economic Policy Research (CEPR)

February 2012

CEPR Discussion Paper No. DP8817

Although naive intuition may indicate the opposite, the existing literature suggests that uncertainty about costs in the homogeneous-good Bertrand model intensifies competition: it lowers price and raises total surplus (but also makes profits go up). Those results, however, are derived under two assumptions that, if relaxed, conceivably could reverse the results. The present paper first shows that the results hold also if drastic innovations are possible. Next, the paper assumes asymmetric cost distributions, a possibility that is empirically highly plausible but which has been neglected in the previous literature. Using numerical methods it is shown that, under this assumption, uncertainty lowers price and raises total surplus even more than with identical distributions. However, if the asymmetry is large enough, industry profits are lower under uncertainty; this is in contrast to the known results and reinforces the notion that uncertainty intensifies competition rather than softens it.

Number of Pages in PDF File: 31

Keywords: asymmetric auctions, asymmetric firms, auctions with endogenous quantity, Bertrand competition, boundary value method, Hansen-Spulber model, information sharing, oligopoly, private information

JEL Classification: D43, D44, L13

Date posted: March 1, 2012  

Suggested Citation

Lagerlöf, Johan N. M., Does Cost Uncertainty in the Bertrand Model Soften Competition? (February 2012). CEPR Discussion Paper No. DP8817. Available at SSRN: http://ssrn.com/abstract=2013808

Contact Information

Johan N. M. Lagerlof (Contact Author)
University of Copenhagen - Department of Economics ( email )
Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
HOME PAGE: http://www.johanlagerlof.org
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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