Why Are Duopolies So Competitive?
Copyright 2006 Geoff Gannon
Duopolies can be surprisingly competitive. If you remember that
the price of a product or service is determined solely by the
highest losing bid price and the lowest losing ask price, you'll
realize why a duopoly can be so competitive. A large number of
inefficient competitors will have almost no affect on prices in
the long run unless someone (either a government or a group of
idiotic investors) is willing to continually finance
unprofitable operations in an unprofitable industry (think
airlines).
Of course, there is always the fear of a price fixing scheme in
a duopoly. Generally, however, that fear is unfounded. Human
nature suggests a price fixing scheme is far more likely to
occur in an oligopoly than a duopoly. Humans weight the fear of
loss far more heavily than the greed of gain when making
calculations about the future. In a duopoly, mistrust increases
the fear of loss inherent to any price fixing scheme (namely,
the other guy will stab you in the back). In an oligopoly, the
diffusion of power and the lack of excess capacity at any one
firm makes price fixing very attractive. Price fixing in an
oligopoly is a much safer bet than price fixing in a duopoly.
There are, of course, other reasons why a duopoly is very
unlikely to result in a price fixing scheme. In addition to a
healthy does of fear, there is an often unhealthy does of hate
in duopolies. There is always just one scapegoat in a duopoly.
Hatred is a personal emotion; if spread over too many objects it
tends to wane away. Finally, there's the simple fact that both
competitors in a duopoly are likely really big, really agile,
really cutthroat players. The process leading up to a duopoly
tends to be a sort of wolfing run, in which two pups are
separated from the runts.
Having said all that, price fixing is possible in a duopoly.
Some duopolies are not the result of competition but of
nationalization and privatization, although this is relatively
rare since a nationalized monopoly won't often result in a
lasting duopoly (it will either remain a monopoly once
privatized or get crushed by new, private competitors).
Finally, a price fixing scheme always makes more sense in a
commodity business. After all, any product differentiation
limits the degree to which general demand is applicable to
specific competitors' products. For example, Coke and Pepsi are
highly differentiated products, at least when purchased in their
specific packaging (physical differences or similarities are
immaterial here; it is only the buyer's belief that matters). I
drink Pepsi, and I can assure you (however irrational it sounds)
that no drop in the price of Coke would be sufficient to get me
to stop buying Pepsi. There is almost no other tangible good
about which I could say the same. So, clearly Coke and Pepsi are
differentiated products, and there's very little chance of an
effective price fixing scheme between them.