In the model of Bertrand Competition  firms would compete, driving price down to marginal cost so that firms make zero economic profits. This means we have firms essentially behaving as if they are perfectly competitive, even with just two firms. Despite this very clear prediction, we do not often see evidence of this outcome, even in markets where we believe firms are indeed competing via price. Why might this be? For instance, what assumptions do we make about costs of firms and how might things play out if those assumptions fail? What are some things firms could do in this situation to prevent prices from dropping as low as marginal cost, even if our assumptions on costs are true?

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Asked Oct 5, 2019
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  1. In the model of Bertrand Competition  firms would compete, driving price down to marginal cost so that firms make zero economic profits. This means we have firms essentially behaving as if they are perfectly competitive, even with just two firms. Despite this very clear prediction, we do not often see evidence of this outcome, even in markets where we believe firms are indeed competing via price. Why might this be? For instance, what assumptions do we make about costs of firms and how might things play out if those assumptions fail? What are some things firms could do in this situation to prevent prices from dropping as low as marginal cost, even if our assumptions on costs are true?
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