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 15 of
25
…
Figure 2 here
…
In a prisoners’ dilemma situation
cooperation is difficult but not impossible.
Not all prisoners decide to turn in
their partners in crime.
Cartels sometimes hold to collusive
arrangements, despite the incentive for members to defect.
…
Players can solve the prisoners'
dilemma by playing the game many times.
Reconsider the duopolists Jack and
Jill, Figure 2.
Jack and Jill would like to maintain
the cell D monopoly outcome
· each produces 30 gallons a week
· each gains $1,800 profit a week
If Jack and Jill play this game only once neither has incentive to stay with
this agreement.
Self-interest drives both to renege and
choose the dominant 40 gallons strategy, cell A.
…
Suppose Jack and Jill know they will play the same game
every week.
When they make their initial agreement
to keep production low at 30 gallons they can specify what happens if one party
reneges.
They could agree if one reneges and
produces 40 gallons both will produce 40 gallons forever after.
If one party is producing at 40
gallons, the other has reason to do the same.
The threat of this penalty should be
everything needed to maintain cooperation.
Jack and Jill know defecting would
raise his or her profit from $1,800 to $2,000 but this benefit would last for
only one week.
Thereafter, profit would fall to $1,600
and stay there.
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