Question

Briefly explain how situations described by “the prisoner’s dilemma” can result in reduced profits for oligopolies.

Answer 1

It shall be noted that game theory can explain why oligopolies have trouble maintaining collusive arrangements to generate monopoly profits. While firms would be better off collectively if they cooperate, each individual firm has a strong incentive to cheat and undercut their competitors in order to increase the profit and the market share. Because the incentive to defect is strong, firms may not even enter into a collusive agreement.

		Player A
		Betray	Cooperate
Player B	Betray	1 , 1	3, 0
	Cooperate	0 , 3	2, 2

The prisoner’s dilemma is a specific type of game in game theory that illustrates why cooperation may be difficult to maintain for oligopolists even when it is mutually beneficial. In the game, two members of an oligopolistic are assessed about pricing strategy to capture the market. The two oligopolists are separated and left to contemplate their options. If both oligopolists cooperate, each will make a profit of 2 million dollars.

If one cooperates, but the other betrays, the one that cooperates will make a profit of 0 million dollars, while the one that betrays would make 3 million dollars. If both betray, they will both make 1 million dollars. Betraying the partner is the dominant strategy; it is the better strategy for each player regardless of how the other plays. This is known as a Nash equilibrium. The result of the game is that both oligopolists pursue individual logic and betray when they would have collectively gotten a better outcome if they had both cooperated.