What does the prisoners’ dilemma have to do with markets and imperfect competition? It turns out that the game oligopolists play in trying to reach the monopoly outcome is similar to the game that the two prisoners play in the prisoners’ dilemma.

Consider again the choices facing Jack and Jill. After prolonged negotiation, the two suppliers of water agree to keep production at 30 gallons so that the price will be kept high and together they will earn the maximum profit. After they agree on production levels, however, each of them must decide whether to cooperate and live up to this agreement or to ignore it and produce at a higher level. Figure 3 shows howthe profits of the two producers depend on the strategies they choose .

Producing 40 gallons is a dominant strategy for Jack. Of course, Jill reasons in exactly the same way, and so both produce at the higher level of 40 gallons. The result is the inferior outcome (from Jack’s and Jill’s standpoints) with low profits for each of the two producers.

This example illustrates why oligopolies have trouble maintaining monopoly profits. The monopoly outcome is jointly rational for the oligopoly, but each oligopolist has an incentive to cheat. Just as self interest drives the prisoners in the prisoners’ dilemma to confess, self-interest makes it difficult for the oligopoly to maintain the cooperative outcome with low production, high prices, and monopoly profits.

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