Michael Cameron did a very relevant post on his blog ‘Sex, Drugs and Economics’ which focused on the duopoly market structure of New Zealand’s supermarkets. Part of the NCEA Level 3 and the CIE A2 economics courses look at market structures – monopolistic, oligopoly, duopoly, monopoly, and monopsony. A duopoly refers to two firms in a market whilst an oligopoly has a small number of firms but greater than two. Therefore we can say that Oligopoly and Duopoly are very similar market structures and they can co-ordinate their behaviour to exploit the market by lowering competition which in turn leads to greater profits for all.
Using the example of the supermarket duopoly Foodstuffs and Woolworths. Each company has two options – high price or low price. Obviously if they both price low they stand to be worse off and if they price high they are both set to gain. The outcome and payoffs are illustrated below:
Maximax – riskier strategy
A maximax strategy is one where the player attempts to earn the maximum possible benefit available. This means they will prefer the alternative which includes the chance of achieving the best possible outcome – even if a highly unfavourable outcome is possible. This strategy, often referred to as the best of the best is often seen as ‘naive’ and overly optimistic strategy, in that it assumes a highly favourable environment for decision making.
In this case, for both food providers, the aggressive maximax strategy is $140m from a low price and $120m from a high price, so a low price gives the maximax pay-off.
Maximin – conservative strategy
A maximin strategy is where a player chooses the best of the worst pay-off. This is commonly chosen when a player cannot rely on the other party to keep any agreement that has been made – for example, to deny.
In terms of the pessimistic maximin strategy, the worst outcome from a low price is $100m, and from a high price is $70m – hence a low price provides the best of the worst outcomes.
Again, lowering price is the dominant strategy, and the only way to increase the pay-off would be to collude and increase price together. Of course, this requires an agreement, and collusion, and this creates two further risks – one of the food companies reneges on the agreement and ‘rats’, and the competition authorities investigate the food companies, and impose a penalty.
Nash equilibrium, named after Nobel winning economist, John Nash, is a solution to a game involving two or more players who want the best outcome for themselves and must take the actions of others into account. When Nash equilibrium is reached, players cannot improve their payoff by independently changing their strategy. This means that it is the best strategy assuming the other has chosen a strategy and will not change it. For example, in the Prisoner’s Dilemma game, confessing is a Nash equilibrium because it is the best outcome, taking into account the likely actions of others.