Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 5  Firm Behavior and the Organization of Industry

Chapter 17 of 36  Oligopoly

Section 12 of 25

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Figure 3 here

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Figure 3 - An Arms-Race Game

In this game between two countries the safety and power of each country depend on both its decision whether to arm or disarm and the decision made by the other country.

…

The logic of the prisoners' dilemma in which self-interest prevents cooperation and leads to an inferior outcome for the two prisoners applies to many other situations.

In the decades after World War II the world's two military superpowers, the U.S. and the Soviet Union (USSR), were in a competition over military power.

Consider the decisions of the U.S. and the USSR about whether to build new weapons or to disarm.

…

Each country prefers to have more arms than the other because a larger arsenal would give it more relative power

But each country also prefers to live in a safe world.

Figure 3 shows the arm-disarm game.

If the USSR

· chooses to arm, the U.S. is better off arming to prevent loss of power

· chooses to disarm, the U.S. is again better off arming because doing so would make it more powerful

Arming is a dominant strategy for each country.

Thus, each country

· chooses to arm and continue the arms race

· resulting in the inferior arm-arm outcome with both countries at risk

…

The U.S. and the USSR attempted to solve the problem with arms control negotiations and agreements.

The problems for the two countries were similar to those oligopolists face in trying to maintain a cartel.

Just as oligopolists argue over production levels, the U.S. and the USSR argued over the amount of arms each country would be allowed.

Just as cartels have trouble enforcing production levels, the U.S. and the USSR each feared the other country would cheat on any agreement.

In both arms races and oligopolies

· the powerful logic of self-interest

· pushes the participants toward a non-cooperative outcome, in this case both arm

· that is worse for each party

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