IBonomicsGame Theory and Prisoner's Dilemma in OligopolyHL
MicroeconomicsA payoff matrix showing the prisoner's dilemma in an oligopoly, where two interdependent firms choose between a high price and a low price.
Curves and elements
- Oligopoly 1
- One of the two interdependent firms, choosing between a high price and a low price.
- Oligopoly 2
- The other interdependent firm, choosing between a high price and a low price.
- Payoffs
- The profits each firm receives under each combination of strategies, shown in euros.
- Cooperative outcome
- If both firms choose a high price, both earn €1000, which is better for both firms collectively.
- Non-cooperative outcome
- If both firms choose a low price, both earn €300, which is worse for both firms collectively.
- Prisoner's dilemma
- Each firm has an incentive to lower price individually, but if both firms do this, both firms are worse off.
Key explanations
- 1
Game theory examines the strategic behavior of firms that are interdependent, meaning each firm’s decision affects the other.
- 2
The payoff matrix shows the prisoner's dilemma faced by two oligopolists when each chooses either a high price or a low price.
- 3
If both firms choose a high price, both earn €1000, which is the cooperative outcome.
- 4
Whatever the other firm does, each firm earns more by lowering its price. It earns €1500 instead of €1000 if the other keeps a high price, and €300 instead of €200 if the other cuts too. So both firms lower price, and both earn only €300.
- 5
This shows the prisoner's dilemma because individual self-interest can lead both firms to a worse outcome than cooperation.
Example exam question
Explain how a payoff matrix can be used to show the prisoner's dilemma in an oligopoly market.
Show example answer
A payoff matrix shows the possible outcomes for each firm depending on the actions taken. In this case, each firm has an incentive to lower price to increase its own payoff, but if both firms do so, both earn less than if they had both kept prices high, showing the prisoner's dilemma.
