Game theory is the method utilized to understand the behavior of oligopolies or market situations in which each of a few producers affects but does not control the market. Unlike monopolies in which a company has complete control of the entire supply of goods and/or services in a certain market, oligopolies do have competitors with in the market. However, unlike monopolistically competitive firms and perfectly competitive firms, firms within a oligopolistic frame work have so few competitors that marketing and pricing decisions made by one firm has a very unique possibility of affecting all the other ...view middle of the document...
Both companies have the possibility of obtaining a big payoff by charging a minimal price while its competitor charges an elevated price, but both companies know that if one of them cuts it price the other will quickly follow suit, resulting in a smaller payoff for both. The resulting equilibrium is both companies charging a high price and engaging instead in non-price competition.
Coke vs. Pepsi Payoff Matrix
Pepsi charges high price
Pepsi charges low price
Coke charges high price Coke makes large profit
Pepsi makes large profit Coke takes a loss
Pepsi makes very large profit
Coke charges low price Coke makes very large profit
Pepsi takes a loss Coke makes small profit
Pepsi makes small profit
In conclusion, game theory predicts that the companies will match each other's moves: if the products of Coke are endorsed by a pro athlete, Pepsi will in turn try to possibly a TV star. If Coke decides to change its formula, Pepsi will launch an all-out media blitz to make fun of it. To bring it closer to home, if Coke sponsors the Disney for example, Pepsi will sponsor the Universal Studios. The conclusion that needs to be made is this: in an oligopoly, failure by a company to react to its competitor's strategic move will allow its competitor to capture market share and increase its profits. In this case, both companies benefit from each others existence and neither company should have acted any differently.