3a Describe and explain the prisoners dilemma Discuss its im

3a. Describe and explain the prisoners’ dilemma. Discuss its implications for firms’ pricing in an oligopolistic market.

3b. Explain the Dominant Firm Model and apply it to the OPEC cartel to explain why they have been successful in maintaining world oil prices above competitive levels. Use a diagram to illustrate your answer.

Solution

The Prisoners Dilemma.

Two prisoners are held in a separate room and cannot communicate

They are both suspected of a crime

They can either confess or they can deny the crime

Payoffs shown in the matrix are years in prison from their chosen course of action

Prisoner A

Confess

Deny

Prisoner B

Confess

(3 years, 3 years)

(1 year, 10 years)

Deny

(10 years, 1 year)

(2 years, 2 years)

The equilibrium in the Prisoners\' Dilemma occurs when each player takes the best possible action for themselves given the action of the other player.

The dominant strategy is each prisoners\' unique best strategy regardless of the other players\' action

Best strategy? Confess?

A bad outcome! – Both prisoners could do better by both denying – but once collusion sets in, each prisoner has an incentive to cheat!

Prisoner A

Confess

Deny

Prisoner B

Confess

(3 years, 3 years)

(1 year, 10 years)

Deny

(10 years, 1 year)

(2 years, 2 years)