GAME THEORY AND THE
ECONOMICS OF COOPERATION
• Game theory is the study of how people behave
in strategic situations.
• Strategic decisions are those in which each
person, in deciding what actions to take, must
consider how others might respond to that
action.
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GAME THEORY AND THE
ECONOMICS OF COOPERATION
• Because the number of firms in an oligopolistic
market is small, each firm must act
strategically.
• Each firm knows that its profit depends not
only on how much it produces but also on how
much the other firms produce.
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The Prisoners’ Dilemma
• The prisoners’ dilemma provides insight into
the difficulty in maintaining cooperation.
• Often people (firms) fail to cooperate with
one another even when cooperation would
make them better off.
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The Prisoners’ Dilemma
• The prisoners’ dilemma is a particular “game”
between two captured prisoners that illustrates
why cooperation is difficult to maintain even
when it is mutually beneficial.
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Figure 2 The Prisoners’ Dilemma
Bonnie’ s Decision
Confess Remain Silent
Bonnie gets 8 years Bonnie gets 20 years
Confess
Clyde’s Clyde gets 8 years Clyde goes free
Decision Bonnie goes free Bonnie gets 1 year
Remain
Silent
Clyde gets 20 years Clyde gets 1 year
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The Prisoners’ Dilemma
• The dominant strategy is the best strategy for a
player to follow regardless of the strategies
chosen by the other players.
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The Prisoners’ Dilemma
• Cooperation is difficult to maintain, because
cooperation is not in the best interest of the
individual player.
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Figure 3 An Oligopoly Game
Iraq’s Decision
High Production Low Production
Iraq gets $40 billion Iraq gets $30 billion
High
Production
Iran gets $40 billion Iran gets $60 billion
Iran’s
Decision Iraq gets $60 billion Iraq gets $50 billion
Low
Production
Iran gets $30 billion Iran gets $50 billion
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Oligopolies as a Prisoners’ Dilemma
• Self-interest makes it difficult for the oligopoly
to maintain a cooperative outcome with low
production, high prices, and monopoly profits.
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Figure 4 An Arms-Race Game
Decision of the United States (U.S.)
Arm Disarm
U.S. at risk U.S. at risk and weak
Arm
Decision
USSR at risk USSR safe and powerful
of the
Soviet Union U.S. safe and powerful U.S. safe
(USSR)
Disarm
USSR at risk and weak USSR safe
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Figure 5 An Advertising Game
Marlboro’ s Decision
Advertise Don’t Advertise
Marlboro gets $3 Marlboro gets $2
billion profit billion profit
Advertise
Camel gets $3 Camel gets $5
Camel’s billion profit billion profit
Decision
Marlboro gets $5 Marlboro gets $4
billion profit billion profit
Don’t
Advertise
Camel gets $2 Camel gets $4
billion profit billion profit
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Figure 6 A Common-Resource Game
Exxon’s Decision
Drill Two Wells Drill One Well
Exxon gets $4 Exxon gets $3
million profit million profit
Drill Two
Wells
Texaco gets $4 Texaco gets $6
Texaco’s million profit million profit
Decision Exxon gets $6 Exxon gets $5
million profit million profit
Drill One
Well
Texaco gets $3 Texaco gets $5
million profit million profit
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Why People Sometimes Cooperate
• Firms that care about future profits will
cooperate in repeated games rather than
cheating in a single game to achieve a one-time
gain.
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Figure 7 Jack and Jill Oligopoly Game
Jack’s Decision
Sell 40 Gallons Sell 30 Gallons
Jack gets Jack gets
$1,600 profit $1,500 profit
Sell 40
Gallons
Jill gets Jill gets
Jill’s $1,600 profit $2,000 profit
Decision Jack gets Jack gets
$2,000 profit $1,800 profit
Sell 30
Gallons
Jill gets Jill gets
$1,500 profit $1,800 profit
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PUBLIC POLICY TOWARD
OLIGOPOLIES
• Cooperation among oligopolists is undesirable
from the standpoint of society as a whole
because it leads to production that is too low
and prices that are too high.
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Restraint of Trade and the Antitrust Laws
• Antitrust laws make it illegal to restrain trade or
attempt to monopolize a market.
• Sherman Antitrust Act of 1890
• Clayton Act of 1914
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Controversies over Antitrust Policy
• Antitrust policies sometimes may not allow
business practices that have potentially positive
effects:
• Resale price maintenance
• Predatory pricing
• Tying
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Controversies over Antitrust Policy
• Resale Price Maintenance (or fair trade)
• occurs when suppliers (like wholesalers) require
retailers to charge a specific amount
• Predatory Pricing
• occurs when a large firm begins to cut the price of
its product(s) with the intent of driving its
competitor(s) out of the market
• Tying
• when a firm offers two (or more) of its products
together at a single price, rather than separately
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Summary
• Oligopolists maximize their total profits by
forming a cartel and acting like a monopolist.
• If oligopolists make decisions about production
levels individually, the result is a greater
quantity and a lower price than under the
monopoly outcome.
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Summary
• The prisoners’ dilemma shows that self-interest
can prevent people from maintaining
cooperation, even when cooperation is in their
mutual self-interest.
• The logic of the prisoners’ dilemma applies in
many situations, including oligopolies.
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Summary
• Policymakers use the antitrust laws to prevent
oligopolies from engaging in behavior that
reduces competition.
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