Price Competition and Market Concentration: An Experimental Study

The classical price competition model (named after Bertrand), prescribes that in equilibrium prices are equal to marginal costs. Moreover, prices do not depend on the number of competitors. Since this outcome is not in line with real-life observations, it is known as the “Bertrand Paradox”. Many theoretical problems with the original model have been considered as an explanation of the paradox in the literature. In this paper we experimentally investigate a model which is immune to the theoretical critique of the original model. We find, nevertheless, that the outcome does depend on the number of competitors: the Bertrand solution does not predict well when the number of competitors is two, but after some opportunities for learning are provided it tends to predict well when the number of competitors is three or four. A bounded rationality explanation of this is suggested. * We wish to thank Eric van Damme and Georg Kirchsteiger for many helpful comments and suggestions. This paper was conceived while both authors were at the CentER for Economic Research at Tilburg University. We thank CentER for its hospitality and financial support. ** Department of Economics, Uppsala University, Sweden. E-mail: [email protected] *** Department of Economics, University of Haifa, Israel. E-mail: [email protected] (corresponding author)