A duopoly is a market where two businesses jointly control all or almost all the need for a certain good or service. It is the simplest type of oligopoly, characterised by a few firms controlling a market. Both businesses are in a position to generate maximum revenue and split it amongst themselves. The two major firms produce homogeneous or similar goods. The main features of a Duopoly are high barriers to entry, economies of scale and interdependence of firms, and the firm's independence to set price and quantity.
Did You Know? Duopolies can be more stable than oligopolies because the number of firms is smaller.
Overview On Duopoly
If the two competitors agree to collaborate on prices or output, a duopoly may have an identical effect on the market as a monopoly. The chances of a duopoly developing monopolistic market dominance are diminished by the tendency of its members when they decide to compete with one another. In a duopoly market, there is also a possibility that the two players might conspire to raise consumer prices. The limited product selection for customers is another drawback of duopolies.
A prominent example of a duopoly in today's times can be Pepsi and Coca-Cola. Both companies are important players and have a huge global customer base.
The Importance of a Duopoly
Duopolies are important because they force each firm to consider how its actions will affect its rival, i.e., how the rival firm will respond. It impacts how the company operates, how its goods are manufactured, and how its services are advertised, and it can change what and how goods and services are offered and priced. When two firms compete on price, prices tend to fall to or below the cost of production, effectively eliminating any possibility of profit.
As a result, most duopolistic firms find it profitable and generally necessary to agree to form a monopoly, collaborating in setting prices that allow both firms to take one-half of the market space and profit from it.
Prominent Models Of Duopoly
A duopoly market has two companies controlling the entire market virtually for goods and services which are produced and sold. Both companies and intermediaries shape the market they operate.
The Cournot Model of Duopoly
A French economist Augustin Cournot developed the Cournot Model of Duopoly in 1838. Cournot duopoly is also called Cournot competition and is a model of imperfect competition in which two firms with identical price functions compete by selling homogeneous products in a constant market. There are numerous ways to showcase the model. The original version is highly controlled because it assumes that there are identical products and costs in a duopoly.
Cournot assumed two firms that owned a mineral well each and operated at zero cost. They offer their goods in a market where demand is characterised by a straight line (Infinite demand).
Every company operates assuming that its rival will not alter its product, and each company chooses its output to maximise profit.
Such a model is based on the following notions:
- To make and sell a homogeneous product, there are two sellers.
- Each company produces the maximum amount while being blind to the production strategy of its competitors.
- Each company's cost of manufacturing is 0.
- Market forces alone determine the price. Any company sets no price.
- A large number of people purchase the products made by each company.
- New businesses cannot enter the market.
The Bertrand Model of Duopoly
In 1883, Bertrand developed his duopoly model. His model differs from Cournot's in that it assumes each firm expects its competitor to maintain its price regardless of its own pricing decision. Because market demand is constant, each firm seeks to maximise its profit, assuming its competitor's price will not change. The analysis in this model is based on firms' responses to any price change.
The logic goes that if both firms set the same price, but the marginal cost is lower, they will be incentivised to lower their prices and seize the market. As a result, the only equilibrium from which no firm will be willing to diverge is when price equals marginal cost.
Bertrand's model emphasises price competition. Iso-profit curves are used to derive reaction functions. An iso-profit curve is drawn using various combinations of prices charged by rival firms for a given profit level. He assumed only two firms, A and B, with prices measured along the horizontal and vertical axes.
The model is based on several assumptions.
- A homogeneous product is produced by at least two companies which compete.
- Consumers prefer to buy things from a company with a lower price because firms compete by establishing pricing to lure buyers.
- When two businesses have the same pricing, the demand from customers is distributed equally between them.
- The fundamental assumption about technology is that the unit costs of production of each firm are constant, resulting in marginal and average costs that are identical to the market price. This indicates that the business is prepared to provide whatever quantity is required as long as the price it sets is higher than the unit cost (it earns profit on each unit sold).
Comparing the Bertrand and Cournot Models of Duopoly
No model is necessarily better as they both work on different assumptions. Bertrand is typically a better duopoly competition model if capacity and output are easily changeable. The Cournot model is preferable when output and capacity are difficult to modify.
In certain circumstances, the Cournot model can be rephrased as a two-stage model, where businesses choose their capacities in the first stage and engage in Bertrand competition in the second. According to Bertrand, a duopoly will provide better results, the same as those seen in perfect competition and will be sufficient to drive prices down to marginal cost levels.
An Example of Duopoly Market
Firm A and Firm B are two businesses. Firm A is the first to begin producing and selling mineral water from its mineral well. It will produce the specified quantity at the specified price where MC - MR = 0 (Marginal Cost equals Marginal Revenue) maximises profit. At this output level, the elasticity of market demand equals unity, and the firm's total revenue is at its peak. At this level, the cost is zero, and the revenue and profit are both maximum.
In the Cournot duopoly model, the dominant company divides the market in half and distributes shares equally. Here, both businesses adjust and change their output until equilibrium is reached with equal market shares for each business.
Advantages of a Duopoly Market
- Duopoly market is important as they force every company for considering how actions would impact rival and respond accordingly.
- It impacts how every company operates, produces the goods and how it advertises the service.
Disadvantages of a Duopoly Market
- The primary disadvantage of a duopoly is that it limits free trade. Customers' product options are significantly limited due to the market's presence of only two companies.
- Because of existing companies' barriers, it is difficult for new firms to enter the market and gain market share.
- Another disadvantage of a duopoly is price fixing and collusion. As a result, consumers have few options and must continue to pay a high price.
Duopolies tend to function better when operating and to compete on production quantity rather than price. This also helps avoid legal issues and allows each firm to share the profits, achieving price and operating equilibrium within their duopolistic market. The bigger a company, the more efficient it is. As a result, larger and fewer firms in the market should result in lower prices and increased output.
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