We have seen how the prisoners’ dilemma can be used to understand the problem facing oligopolies. The same logic applies to many other situations as well. Here we consider two examples in which self-interest prevents cooperation and leads to an inferior outcome for the parties involved.

Arms Races An arms race is much like the prisoners’ dilemma. To see this, consider the decisions of two countries-the United States and the Soviet Union-about whether to build new weapons or to disarm. Each country prefers to have more arms than the other because a larger arsenal would give it more influence in world affairs. But each country also prefers to live in a world safe from the other country’s weapons.

Figure 4 shows the deadly game. If the Soviet Union chooses to arm, the United States is better off doing the same to pfevent the loss of power. If the Soviet Union chooses to disarm, the United States is better off arming because doing so would make it more powerful. For each country, arming is a dominant strategy. Thus, each country chooses to continue the arms race, resulting in the inferior outcome in which both countries ere at risk.

Throughout the era of the Cold War, the United States and the Soviet Union attempted to solve this problem through negotiation and agreements over arms control. The problems that the two countries faced were similar to those that oligopolists encounter in trying to maintain a cartel. Just as oligopolists argue over production levels, the United States and the Soviet Union argued over the amount of arms that each country would be allowed. And just as cartels have trouble enforcing production levels, the United States and the Soviet Union each feared that the other country would cheat on any’ agreement. In both arms racesand oligopolies, the relentless logic of self-interest drives the participants toward a noncooperative outcome that is worse for each party.

Imagine that two oil companies-Exxon and Chevron=-own adjacent oil fields. Under the fields is a common pool of oil worth $12 million. Drilling a well to recover the oil costs $1 million. If each company drills one well, each will get half of the oil and earn a $5 million profit ($6 million in revenue minus $1 million in costs).

Because the pool of oil is a common resource, the companies will not use it efficiently. Suppose that either company could drill a second well. If one company has two of the three wells, that company gets two-thirds of the oil, which yields a profit of $6 million. The other company gets one-third of the oil, for a profit of $3 million. Yet if each company drills a second well, the two companies again split the oil. In this case, each bears the cost of a second well, so profit is only $4 million for each company.

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