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| Duopoly |
What It Is:
A duopoly is a form of oligopoly occurring when two companies (or countries)
control all or most of the market for a product or service.
How It Works/Example:
There are two kinds of duopolies. In the first, the Cournot duopoly, competition
between the two companies is based on the quantity of products supplied. The
duopoly members essentially agree to split the market. The price each company
receives for the product is based on the quantity of items produced, and the two
companies react to each other's production changes until an equilibrium is
achieved.
In a Bertrand duopoly, the two companies compete on price. Because consumers
will purchase the cheaper of two identical products, this leads to a zero-profit
price as the two competitors attempt to attract more customers (and thus more
profit) through price cuts. The threat of price undercutting means that Bertrand
equilibrium prices and profits are generally lower (and quantities higher) than
in Cournot duopolies.
A duopoly forces each producer to carefully consider its rival's potential
reactions to certain business decisions. When members of a duopoly compete on
price, they tend to drive the product's price down to the cost of production,
thereby lowering profits for both members of the duopoly.
These circumstances give duopolists a strong incentive to agree to charge a
monopoly price and share the resulting profits. However, federal antitrust laws,
most notably the Sherman Act, make collusive activity illegal in the United
States. Additionally, each member of a duopoly still has an incentive to
compete, even while colluding with the competition. An undetected price
adjustment will attract customers who are buying from the competition and
customers who are not buying the product at all. Price adjustments may be
subtle, including better credit terms, faster delivery, or related free
services.
Duopolies are most effective when the demand for the duopoly's product is not
greatly affected by price. This is also why duopolies are more effective in the
short term; over the long term, prices often become more elastic as consumers
find substitutes for the product. Also, demand volatility may lead to
disagreements within a collusive duopoly regarding outputs and prices.
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