Question

The prisoners’ dilemma is a story about two captured criminals, in which each criminal’s sentence depends on his or her decision to confess and the decision made by the other criminal.

Identify two examples that show how the prisoners’ dilemma helps to explain individual behavior

Explain the circumstances of each example and identify the choices each party faces.

What do you think is the dominant strategy in each example?

Answer 1

Answer

Example 1: Circumstances, choices available and the dominant strategy

Consider two firms, say Coca-Cola and Pepsi, selling similar products. Each must decide on a pricing strategy. They best exploit their joint market power when both charge a high price; each makes a profit of ten million dollars per month. If one sets a competitive low price, it wins a lot of customers away from the rival. Suppose its profit rises to twelve million dollars, and that of the rival falls to seven million. If both set low prices, the profit of each is nine million dollars. Here, the low-price strategy is akin to the prisoner’s confession, and the high-price akin to keeping silent. Call the former cheating, and the latter cooperation. Then cheating is each firm’s dominant strategy, but the result when both “cheat” is worse for each than that of both cooperating.

Example 2: Circumstances, choices available and the dominant strategy

Imagine two car manufacturers, Row Cars and Col Motors. As the only two actors in their market, the price each sells cars at has a direct connection to the price the other sells cars at. If one opts to sell at a higher price than the other, they will sell fewer cars as customers transfer. If one sells at a lower price, they will sell more cars at a lower profit margin, gaining customers from the other.Thus, if both set their prices high, both will make $100 million per year. Should one decide to set their prices lower, they will make $150 million while the other makes nothing. If both set low prices, both make $20 million. Here, the firms decide to keep the prices "low" even though they could have earned more by cooperating and keeping the prices high. Thus, "low prices" is the dominant strategy of both the players.