Does Cost Uncertainty in the Bertrand Model Soften Competition?

Working Paper: CEPR ID: DP8817

Abstract: 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.

Keywords: Asymmetric Auctions; Asymmetric Firms; Auctions with Endogenous Quantity; Bertrand Competition; Boundary Value Method; Hansen-Spulber Model; Information Sharing; Oligopoly; Private Information

JEL Codes: D43; D44; L13

Causal Claims Network Graph

Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.

Causal Claims

Cause	Effect
Cost uncertainty (D89)	Lower prices (D49)
Cost uncertainty (D89)	Total surplus (D69)
Cost uncertainty (D89)	Expected industry profits (L19)

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