9781118041581

Price Competition 371

the suspects will be charged and convicted of a serious crime that carries a

five-year sentence. Without confessions, convictions will be for much shorter

jail terms.

Obviously, each suspect seeks to minimizetime spent in jail. A careful look

at Table 9.3 shows that each prisoner’s best strategy is to confess. (If his or her

accomplice stays mum, confessing brings the shortest sentence, one year. If

the partner confesses, so too must the suspect to avoid a maximum term.)

Without the benefit of communication, there is no way for the partners to

agree to stay mum. The individual incentive is for each to turn state’s evi-

dence. By cleverly constructing the configuration of possible jail terms, the

authorities can induce the suspects to make voluntary confessions, resulting

in five-year prison terms.

TABLE 9.3

The Prisoner’s Dilemma

Each suspect’s optimal

strategy is to confess

and turn state’s evi-

dence on the other.

Suspect 2

Stay Mum Confess

Stay Mum 2 years, 2 years 8 years, 1 year

Suspect 1

Confess 1 year, 8 years 5 years, 5 years

The prisoner’s dilemma should be viewed as a general model rather than

as a special (perverse) case. Once one has the model in mind, it is easy to iden-

tify countless situations in which it applies:

• In the superpowers’ arms race, it is advantageous for one country to
  have a larger nuclear arsenal than its rival. But arms escalation by both
  sides improves neither side’s security (and probably worsens it).


• A cartel has a collective interest in restricting output to earn a
  monopoly profit. At the same time, cartel members can increase their
  individual profits by cheating on the cartel, that is, exceeding their
  quotas. (Recall the discussion in Chapter 8.)


• Abnormally cold winter temperatures bring the threat of a shortage of
  natural gas for heating buildings and homes. State and city officials
  urge residents to turn down their thermostats to conserve natural gas.
  Unfortunately, the result is a negligible reduction in use. (Why should
  I suffer low temperatures when my personal energy saving will have
  no discernible impact on the shortage?)


• The utilization of public resources, most commonly natural resources,
  presents similar dilemmas. For instance, many countries fish the

c09Oligopoly.qxd 9/29/11 1:32 PM Page 371