The most popular game theory illustration is called “prisoners’ dilemma.” Two people have been arrested for a crime;
however, the evidence against them is weak. The sheriff keeps the prisoners separated and offers each a special deal. If
one prisoner confesses, that prisoner can go free as long as only he confesses, and the other prisoner will get 10 or more
years in prison. If both prisoners confess, each will receive a reduced sentence of 2 years in jail. The prisoners know
that if neither confesses, they will be cleared of all charges and will be released in 2 days. The problem here is that nei-
ther prisoner knows what deal the other is being offered or if he will take the deal.
Figure 10-10 shows the options each prisoner has.
Figure 10-10Cartels and Collusions
Collusionis an informal agreement between firms to set output and prices with the intention of controlling the market.
A cartelis a formal agreement between producers to set output and prices to control the market and maximize profits.
An example of a cartel is the Organization of the Petroleum Exporting Countries (OPEC). Collusion and cartels are ille-
gal in the United States.
Chapter Review Questions
- Which of the following is true regarding perfectly competitive firms?
A. There are very few firms in the market.
B. They have slightly differentiated products.
C. It is difficult to start a business in this type of market.
D. There is no long-run profit.
E. There is a gradual profit margin. - Monopolies compared to perfectly competitive firms are inefficient because:
A. They produce output with costs exceeding revenue.
B. They produce more output than is demanded by consumers.
C. They charge a price that is less than marginal revenue.
D. They charge a price that is greater than marginal cost.
E. They charge a price that is less than average total cost.
2 years
2 yearsConfessConfess2 Days
10 years10 years
2 DaysNo ConfessionPrisoner B OptionsPrisoners' DilemmaPrisoner A Options2 Days
No 2 Days
ConfessionProduct Markets and Profit Maximization