A duopoly is a market where only two firms dominate and each firm’s decisions affect the other. In a duopoly, companies might choose strategies like setting a high price, lowering prices, increasing output, or limiting production. A payoff matrix helps show the profit each firm earns depending on what both firms choose.
What makes this important is that neither firm can make decisions independently. Each one has to think about how its rival will react. For example, if both firms keep prices high, they may both earn strong profits. But if one firm lowers its price while the other keeps prices high, the firm that cuts prices may attract more customers and earn more, while the other loses profit. If both firms cut prices, though, they may both end up worse off.
This is why duopolies are often studied in game theory. A payoff matrix can reveal whether firms have a dominant strategy and whether they end up at a Nash equilibrium, where neither firm wants to change its choice given the other firm’s decision. Overall, payoff matrices make it easier to see why competition in a duopoly can push firms toward outcomes that are not always best for either side.
Turns out that in any case, assuming that you do not know what action the other firm decides on, it is always better to defect and lower your prices.
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