A duopoly exists when two companies control almost the entire market for a specific product or service. Surprisingly, duopolies can foster intense competition.
The key to understanding this lies in how prices are determined: they reflect the highest rejected bid and the lowest unaccepted offer. Numerous inefficient competitors have little long-term impact unless an external entity, like a government or investors, continuously funds unprofitable ventures, as seen in the airline industry.
The fear of price-fixing is a common concern in duopolies. However, such schemes are more likely in oligopolies. Human psychology plays a role; the fear of loss outweighs the allure of gain when considering future outcomes. In a duopoly, mistrust amplifies the risk associated with price-fixing – the concern that the other party will betray the agreement.
Conversely, in an oligopoly, the distributed power and lack of excess capacity make price-fixing more appealing and less risky. Besides fear, duopolies often involve intense rivalry. There’s typically a clear ‘scapegoat,’ and animosity is concentrated, making it a potent factor. Furthermore, duopolies often result from a fierce competitive process, where only the strongest survive.
While price-fixing is possible, it’s less common in duopolies. Some duopolies arise from nationalization and privatization, though this is rarer. A nationalized monopoly, once privatized, tends to either remain a monopoly or be overtaken by new, private competitors.
Price-fixing is more viable in commodity businesses. Product differentiation limits the effectiveness of applying general demand to specific competitors. For example, Coke and Pepsi, despite any physical similarities, are perceived as distinct products. A Pepsi drinker is unlikely to switch to Coke even if the latter’s price drops significantly. This differentiation makes effective price-fixing between them highly improbable.