Question

Describe how the prisoner's dilemma can be converted into a business strategy context, e.g. in a pricing game where the strategy is increase price or leave price unchanged or the decision to enter or not enter a market.

Answer 1

Application of Prisoner's dilemma in the business world can be seen when two competitors are battling it out in the marketplace like in a duopoly. In such kind of marketplace, firms collude to create a monopoly solution. As long as each firm upholds the agreement, they will earn the maximum profit.

Suppose there are two companies A and B and assume that A is thinking of cutting the price of its product. If it does so, B may have no choice but to follow suit for its product to retain its market share. This may result in a significant drop in profits for both companies.

A price drop by either company may thus be construed as cheating since it breaks an implicit agreement to keep prices high and maximize profits. Thus, if A drops its price but B continues to keep prices high, the former is changing, while the latter is not changing (by sticking to the spirit of the implicit agreement). In this scenario, company A may win market share and earn incremental profits.

A AND B Payoff Matrix	A
		Unchanged	Change
B	Unchanged	$150,150	$0, $200
	Change	$200, $0	$100, $100

If both keep prices high and unchanged, profits for each company increase by $150 million.

If one drops prices (i.e., change) but the other does not (unchanged), profits increase by $200 million for the former.

If both companies reduce(i.e both change) prices, the increase in product consumption offsets the lower price, and profits for each company increase by $100 million.