Oligopolies As A Prisoners Dilemma

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 an oligopoly with two members, called Iran and Iraq. Both countries sell crude oil. After prolonged negotiation, the countries agree to keep oil production low in order to keep the world price of oil high. After they agree on production levels, each country must decide whether to cooperate and live up to this agreement or to ignore it and produce at a higher level. Figure 16-3 shows how the profits of the two countries depend on the strategies they choose.

Suppose you are the president of Iraq. You might reason as follows: "I could keep production low as we agreed, or I could raise my production and sell more oil on world markets. If Iran lives up to the agreement and keeps its production low, then my country earns profit of $60 billion with high production and $50 billion with low production. In this case, Iraq is better off with high production. If Iran fails to live up to the agreement and produces at a high level, then my country earns $40 billion with high production and $30 billion with low production. Once again, Iraq is better off with high production. So, regardless of what Iran chooses to do, my country is better off reneging on our agreement and producing at a high level."

Producing at a high level is a dominant strategy for Iraq. Of course, Iran reasons in exactly the same way, and so both countries produce at a high level. The

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