Economics Oligopoly Questions Medium
The prisoner's dilemma is a concept in game theory that illustrates the conflict between self-interest and cooperation in oligopoly. In an oligopoly, a market structure characterized by a small number of firms dominating the industry, each firm must make strategic decisions regarding pricing and production levels.
The prisoner's dilemma arises when two firms in an oligopoly face the choice of either cooperating with each other or pursuing their own self-interest. The dilemma occurs because the outcome that maximizes the collective welfare of both firms is different from the outcome that maximizes each firm's individual profit.
If both firms choose to cooperate and set a high price, they can collectively maximize their profits. However, there is a temptation for each firm to deviate from cooperation and lower its price to gain a larger market share and increase its own profits. This is because if one firm lowers its price while the other maintains a high price, the firm with the lower price will attract more customers and gain a competitive advantage.
The dilemma arises from the fact that if both firms choose to deviate and lower their prices, they will end up in a worse-off situation compared to if they had both cooperated. This is because the price war resulting from their individual pursuit of self-interest will lead to lower profits for both firms.
The prisoner's dilemma highlights the inherent tension between cooperation and self-interest in oligopoly. It demonstrates that even though cooperation would benefit both firms in the long run, the temptation to deviate and pursue individual gain often leads to a suboptimal outcome for all parties involved.